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All Items in Millions of Dollars

0 1 2 3
1987 1988 1989 1990
Net Income (Millions) 156.61 141.00 138.22
Total Dividends (Millions) 111.47 112.58 114.81
Book Value Equity (Millions) 1106.30
Cash Flow From Operations (Millions) 602 460 381
Cash Flow From Investing Activities -207 -191 -211
Cash Flow From Financing Activities 148 160 -203

Book Value of Liabilities and Pref Stock $2,290

Observed Share Price (4/1/1988) $20.88


Initial Cost of Equity (You Derive) 17.00%
Perpetuity Growth Rate (g)

Fill in the subsequent worksheets to derive a share value at the end of 1987. Assume a WACC
Estimate the cost of equity. Assume 55.733 million shares outstanding and that Free Cash flo
Assume from 1997 forward that Dividends will be $2.00 per share with no growth

WACC 9.00%
Kd 6.00%
Shares Outstanding 55,733,000
FCF 322,000,000
4 5 6 7 8 9
1991 1992 1993 1994 1995 1996
131.53 133.76 139.33 132.09 138.78 132.09
117.04 119.27 121.50 126.51 236.31 87.50

403 379 499 533 531 534


-301 -243 -302 -216 -160 -322
-64 118 132 151 -98 102

of 1987. Assume a WACC = 0.09 and a cost of Debt = 0.06


ng and that Free Cash flow from 1997 on will be 322 million
h no growth
0 1 2 3
1987 1988 1989 1990
EPS (Earnings Per Share) 2.81 2.53 2.48
DPS (Dividends Per Share) 2.00 2.02 2.06
BPS (Book Value Equity per Share) 19.85
Cash Flow From Operations 10.80 8.25 6.84
Cash Flow From Investing Activities -3.71 -3.43 -3.79
Cash Flow From Financing Activities 2.66 2.87 -3.64

Book Value of Debt and Pref Stock (Millions) $2,290

Observed Share Price (4/1/1988) $20.88


Initial Cost of Equity (You Derive) 0.17
Perpetuity Growth Rate (g)

Fill in the subsequent worksheets to derive a share value at the end of 1987. Assume a WACC
Estimate the cost of equity. Assume 55.733 million shares outstanding and that Free Cash flo
Assume from 1997 forward that Dividends will be $2.00 per share with no growth
4 5 6 7 8 9 10
1991 1992 1993 1994 1995 1996
2.36 2.40 2.50 2.37 2.49 2.37
2.10 2.14 2.18 2.27 4.24 1.57

7.23 6.80 8.95 9.56 9.53 9.58


-5.40 -4.36 -5.42 -3.88 -2.87 -5.78
-1.15 2.12 2.37 2.71 -1.76 1.83

d of 1987. Assume a WACC = 0.09 and a cost of Debt = 0.06


ding and that Free Cash flow from 1997 on will be 322 million
with no growth
Discounted Dividends Approach WACC(AT) 0.09 Kd 0.06 Ke 0.17
Perp
Relevant Valuation Item 0 1 2 3 4 5 6 7 8 9 10
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
DPS (Dividends per Share) 2.0000 2.0200 2.0600 2.1000 2.1400 2.1800 2.2700 4.2400 1.5700 2.00
PV Factor 0.8547 0.7305 0.6244 0.5337 0.4561 0.3898 0.3332 0.2848 0.2434
PV YBY Dividends 1.71 1.48 1.29 1.12 0.98 0.85 0.76 1.21 0.38

Total PV of YBY Dividends (Time=0) 9.76


PV TV Perpetuity 2.86 11.76471
Model Price (12/31/1987) 12.63
Time Consistent FV Factor 1.04
Time Consistent Model Price (4/1/1988) 13.13

Observed Share Price (4/1/1988) $20.88


Initial Cost of Equity (You Derive) 17.00%
Perpetuity Growth Rate (g) 0.00%

Fill in the worksheet to derive a share value at the end of 1987. Assume a WACC = 0.09 and a cost of Debt = 0.06
Estimate the cost of equity. Assume 55.733 million shares outstanding and that Free Cash flow from 1997 on will be 322 million
Assume from 1997 forward that Dividends will be $2.00 per share with no growth

Sensitivity Analysis
g
13.13 0.00% 0.75% 1.50% 2.25% 3.00%
11% 5%
14% UB 21.92
Ke

17% LB 19.84
20%
23%
More Values Falling Below LB (Colored Red) Overvalued
More Values Falling Above LB (Colored Green) Undervalued
10% 20%
22.97 25.06
18.79 16.70
Discounted Free Cash Flow WACC(AT) 0.09

0 1 2 3
1987 1988 1989 1990
Cash Flow From Operations (Millions) 7 8
Cash Flow From Investing Activities (3) (4)

FCF Firm's Assets 5 4


PV Factor (WACC or Ke?) 0.935 0.873 0.816
PV YBY Free Cash Flows 4.21 3.49 0.00

Total PV YBY FCF 7.70 100%


FCF Perp 0.00 0%
Market Value of Assets (12/31/87) 7.70 100%
Book Value Debt & Preferred Stock 2,290.00
Market Value of Equity -2,282.30
divide by Shares to Get PPS at 12/31 55.733
Model Share Price $ (40.95) $(41.65) 0%
5%
FV Factor 1.0170585 7%
Time consistent Price (4/1/88) $ (41.65) 9%
Observed Share Price (4/1/1988) $ 20.88 11%
13%
WACC (AT) 7%
Perp Growth Rate 2% You cannot have a (negative) stock pr
negative = 0

Observed Share Price $20.88


Initial WACC 0.09
Perpetuity Growth Rate (g)

Fill in the worksheet to derive a share value at the end of 1987. Assume a WACC = 0.09 and a
Estimate the cost of equity. Assume 55.733 million shares outstanding and that Free Cash flo
Kd 0.06 Ke 0.17

4 5 6 7 8 9 10
1991 1992 1993 1994 1995 1996 1997

0 0 0 0 0 0
0.763 0.713 0.666 0.623 0.582 0.544
0.00 0.00 0.00 0.00 0.00 0.00

0.00

1% 2% 3% 4% 10%
UB 22.968
LB 18.792

not have a (negative) stock price, so anything


=0

sume a WACC = 0.09 and a cost of Debt = 0.06


nding and that Free Cash flow from 1997 on will be 322 million
All Items in Millions of Dollars

Annual Change in RI (Link to AEG) (23.28) (7.62)

Forecast ROE 14.2% 12.2% 11.7%

0 1 2 3
1987 1988 1989 1990
Net Income (Millions) 156.61 141.00 138.22
Total Dividends (Millions) 111.47 112.58 114.81
Book Value Equity (Millions) 1,106.30 1,151.44 1,179.87 1,203.28

Annual Normal Income (Benchmark) 188.07 195.75 200.58


Annual Residual Income (31.46) (54.74) (62.36)
PV Factor 0.855 0.731 0.624
YBY PV RI (26.89) (39.99) (38.94)

% Change in RI 74% 14%

Book Value Equity (Millions) 1,106.30 137%


Total PV of YBY RI (269.39) -33%
Terminal Value Perpetuity (26.84) -3% 15.12
MVE 12/31/87 810.07 100% 11%
divide by shares 55.733 14%
Model Price on 12/31/87 $ 14.53 Ke 17%
Time Consistent Factor 1.040 20%
Time Consistent Price (4/1/1988) $ 15.12 23%

Observed Share Price (4/1/1988) $ 20.88


Initial Cost of Equity (You Derive) 17%
Perpetuity Growth Rate (g) -30%

Fill in the subsequent worksheets to derive a share value at the end of 1987. Assume a WACC
Estimate the cost of equity. Assume 55.733 million shares outstanding and that Free Cash flo
Assume from 1997 forward that Dividends will be $2.00 per share with no growth
(10.67) (0.23) 3.11 (10.28) 5.74 9.89

10.9% 11.0% 11.3% 10.6% 11.1% 11.4%

4 5 6 7 8 9 Perp
1991 1992 1993 1994 1995 1996 1997
131.53 133.76 139.33 132.09 138.78 132.09
117.04 119.27 121.50 126.51 236.31 87.50
1,217.77 1,232.26 1,250.09 1,255.66 1,158.13 1,202.72

204.56 207.02 209.48 212.52 213.46 196.88


(73.03) (73.26) (70.15) (80.43) (74.69) (64.80) (51.84)
0.534 0.456 0.390 0.333 0.285 0.243
(38.97) (33.42) (27.35) (26.80) (21.27) (15.77)

17% 0% -4% 15% -7% -13%

Decay Rate
-10.00% -20.00% -30.00% -40.00% -50.00% (110.29)

UB - 10% $ 16.63
LB - 10% $ 13.60

of 1987. Assume a WACC = 0.09 and a cost of Debt = 0.06


ng and that Free Cash flow from 1997 on will be 322 million
th no growth
WACC(AT) 0.09 Kd
WACC (AT) 9% Kd

0 1 2 3
1987 1988 1989 1990 1991
Net Income (Millions) 156.61 141.00 138.22 131.53
Total Dividends (Millions) 111.47 112.58 114.81 117.04

Dividends Reinvested at 17% (Drip) 18.95 19.14 19.52


Cum-Dividend Earnings 159.95 157.36 151.05
Normal Earnings 183.23 164.98 161.71
Abnormal Earning Growth (AEG) (23.28) (7.62) (10.67)
PV Factor 0.85 0.73 0.62
PV of AEG (19.90) (5.57) (6.66)

Residual Income Check Figure (23.28) (7.62) (10.67)

Core Net Income 156.61


Total PV of YBY AEG (30.11)
PV of Terminal Value 7.19
Total Adjusted Forward Annual Net Income 133.70

Divide by shares to Get Average EPS Perp 55.733


Average Forward EPS 2.40
Capitalization Rate (Perpetuity) = Ke 17% 14.68
11%
14%

Ke
Intrinsic Value Per Share (12/31/1987) $ 14.11 17%
Time Consistent Factor 1.040 20%
time consistent implied price 4/1/1988 $ 14.68 23%

April 1, 1988 observed price $ 20.88 Price & Discount Rates are inv
Ke 17%
g (Decay Rate) -30% If you have a positive peretuity

Actual Price per share


Estimate the cost of equity. Assume 55.733 million shares outstanding and that Free Cash flow from 1997 on will be 322 mi
0.06 Ke 0.17
6% Ke 17%

4 5 6 7 8 9
1992 1993 1994 1995 1996 1997
133.76 139.33 132.09 138.78 132.09
119.27 121.50 126.51 236.31 87.50
Pure I/S & Cash Flow Approach
19.90 20.28 20.65 21.51 40.17 Benchmark Income & DRIP Income are Ke depend
153.66 159.61 152.74 160.28 172.26 Benchmark Net Income because you use
153.89 156.50 163.02 154.54 162.37 Ke to forecast Incomes
(0.23) 3.11 (10.28) 5.74 9.89 11.87
0.53 0.46 0.39 0.33 0.28
(0.12) 1.42 (4.01) 1.91 2.82

(0.23) 3.11 (10.28) 5.74 9.89

25.26

Decay Rate
-10% -20% -30% -40% -50%

UB-10% $ 22.97
LB-10% $ 18.79

Price & Discount Rates are inversly related


Lower Discount Rate = Higher Price
If you have a positive peretuity value, you want lower decay rate
Lower Decay Rate = Keep good value longer
Higher Decay Rate = Lose good value fast

flow from 1997 on will be 322 million


ow Approach
& DRIP Income are Ke dependen
ark Net Income because you use
ecast Incomes
Book Value of Equity 1,106.30
Ke 17%
g -30% Decay R
Long-Run ROE 12% 18.45 -10.00%
11%
Model Price (12/31/87) 988.61 14%

Ke
# of Shares Outstanding 55.733 17%
Model Share Price (12/31/87) $ 17.74 20%
Time Consistent Factor 1.04 23%
Time Consistent Model Price $ 18.45
ROE
Observed Share Price $20.88 18.45 10.00%
11%
14%

Ke
17%
20%
23%
Numerator: ROE - Ke --> If (-) then thats bad and you want a
higher decay rate, get rid of it quicker Decay R
18.45 -10.00%
10%
11%

ROE
12%
13%
14%
Decay Rate
-20.00% -30.00% -40.00% -50.00%

ROE @ 12%
UB-10% $ 20.29
LB-10% $ 16.60

ROE

Decay Rate @ 30%


11.00% 12.00% 13.00% 14.00%

UB-10% $ 20.29
LB-10% $ 16.60

Decay Rate
-20.00% -30.00% -40.00% -50.00%

Ke @ 17%

UB-10% $ 20.29
LB-10% $ 16.60