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# Chapter 18 - PowerPoint PPT Presentation

Equity Valuation Models. Chapter 18. Models of Equity Valuation. Basic Types of Models Balance Sheet Models Dividend Discount Models Price/Earning Ratios Estimating Growth Rates and Opportunities. Intrinsic Value and Market Price. Intrinsic Value Self assigned Value

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## PowerPoint Slideshow about ' Chapter 18' - callum-sampson

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### Chapter 18

• Basic Types of Models

• Balance Sheet Models

• Dividend Discount Models

• Price/Earning Ratios

• Estimating Growth Rates and Opportunities

• Intrinsic Value

• Self assigned Value

• Variety of models are used for estimation

• Market Price

• Consensus value of all potential traders

• IV < MP Sell or Short Sell

• IV = MP Hold or Fairly Priced

V0 = Value of Stock

Dt = Dividend

k = required return

Stocks that have earnings and dividends that are expected to remain constant.

Preferred Stock

E1 = D1 = \$5.00

k = .15

V0 = \$5.00 / .15 = \$33.33

g = constant perpetual growth rate

E1 = \$5.00 b = 40% k = 15%

(1-b) = 60% D1 = \$3.00 g = 8%

V0 = 3.00 / (.15 - .08) = \$42.86

g = growth rate in dividends

ROE = Return on Equity for the firm

b = plowback or retention percentage rate

(1- dividend payout percentage rate)

PN = the expected sales price for the stock at time N

N = the specified number of years the stock is expected to be held

PVGO = Present Value of Growth Opportunities

E1 = Earnings Per Share for period 1

ROE = 20% d = 60% b = 40%

E1 = \$5.00 D1 = \$3.00 k = 15%

g = .20 x .40 = .08 or 8%

Vo = value with growth

NGVo = no growth component value

PVGO = Present Value of Growth Opportunities

• P/E Ratios are a function of two factors

• Required Rates of Return (k)

• Expected growth in Dividends

• Uses

• Relative valuation

• Extensive Use in industry

• E1 - expected earnings for next year

• E1 is equal to D1 under no growth

• k - required rate of return

b = retention ratio

ROE = Return on Equity

E0 = \$2.50 g = 0 k = 12.5%

P0 = D/k = \$2.50/.125 = \$20.00

PE = 1/k = 1/.125 = 8

b = 60% ROE = 15% (1-b) = 40%

E1 = \$2.50 (1 + (.6)(.15)) = \$2.73

D1 = \$2.73 (1-.6) = \$1.09

k = 12.5% g = 9%

P0 = 1.09/(.125-.09) = \$31.14

PE = 31.14/2.73 = 11.4

PE = (1 - .60) / (.125 - .09) = 11.4

• Use of accounting earnings

• Historical costs

• May not reflect economic earnings

• Reported earnings fluctuate around the business cycle.

• Price-to-Book

• Price-to-Cash Flow

• Price-to-Sales

• Inflation has an impact on equity valuations.

• Historical costs underestimate economic costs.

• Empirical research shows that inflation has an adverse effect on equity values.

• Research shows that real rates of return are lower with high rates of inflation.

• Shocks cause expectation of lower earnings by market participants.

• Returns are viewed as being riskier with higher rates of inflation.

• Real dividends are lower because of taxes.