BA 3303 (Moore)
Chapter 11 – Valuation
Fall 2006
Chapter 11 – Prospective Analysis: Valuation Theory Basics
Complete Auto Industry Valuation Sheet
Key Learning Outcomes







Developing a broad set of valuation measures
The ability to estimate the appropriate cost of capital
Working with growth rates and terminal values (equilibrium)
Valuation with Multiples (screening methods)
Theory based valuation models
Understanding the residual income and abnormal earnings valuation models
Matching costs of capital with financial statement data and forecasts
Earnings Multiples Valuation
(Method of Comparables)
1992
1993
Company
EPS BPS DPS PPS
EPS BPS DPS PPS
Chrysler
Daimler-Benz
Federal Signal
Ford Motor, Canada
Ford Motor, US
General Motors, US
Honda Motor, Ltd.
Navistar, Intl.
Paccar, Inc.
2.21 25.5 0.60 32.25
Not Traded in US
1.00 5.23 0.42 21.25
-35 64.2 0.00 85.5
-15.6 30.1 1.60 42.88
-38.3 8.47 1.40 32.25
0.67 18.31 0.24 25.50
-0.95 0.37 0.00 1.88
1.93 30.7 1.30 57.25
-7.62
0.74
1.15
-22.5
4.55
2.13
0.47
-15.5
4.21
19.3
21.7
5.81
39.9
31.2
7.77
19.3
7.10
32.8
0.65
8.01
0.48
0.00
1.60
0.80
0.27
0.00
0.00
53.25
48.63
28.00
95.50
64.50
54.88
32.38
27.25
61.25
Required:
a. Calculate estimated prices in 1992 and 1993 for Chrysler using averages
multiples of earnings, book values and dividends of the other firms in the
industry. Which valuation comes closest to the actual price?
b. List and explain the reservations (problems) you identify in using the
multiples.
c. All else being equal, would you expect the price of a firm with a high
dividend payout ratio to be higher or lower than that of comparison firms?
Explain.
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BA 3303 (Moore)
Chapter 11 – Valuation
Fall 2006
Method of Comparables (Mechanics and Logic) – Screening Tool
A. Determine Relevant Valuation Multiples
1. Take relevant industry averages (excluding firm to be analyzed)
a. Omit negative values and (possibly) large outliers
2. Possible measure to use:
a. P/E (trailing)
b. P/E (forecast)
c. P/B
d. D/P
e. P.E.G. (Price/Earnings) / (1-Year ahead Earnings Growth Rate)
f. P/EBITDA (un-levered measure)
g. P/(FCF per share)

FCF = CFFO + CFFI (physical assets) +/- CFFF (Change in Debt)
h. (Enterprise Value)/EBITDA

Enterprise Value = MVE + Book Value of Liabilities – Cash Items
B. Compute Value based on Average Multiple (comparable) and forecast metric
1. Example for P/E (forecast)
average
 P
PPSassessed, t  E ( EPSt 1 ) *  
 E  comparable firms
C. Examine Price (PPS) assessment across all multiples.
1. Commonly, there exist a wide range of values
2. No “theory” to state which valuation multiple is “best”
3. Keep in mind you are not doing an “intrinsic” valuation
a.
Industry average benchmarks are determined by market
consensus
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Chapter 11 – Valuation
BA 3303 (Moore)
Fall 2006
Intrinsic Valuation Methods
A. Intrinsic Valuation
1. Involves Detailed Forecasts and Analysis
2. Requires substantial professional judgment and estimates
3. Is the analyst’s “opinion” (assessment) of firm value (not consensus)
4. Can help identify under-valued; over-valued; and “reasonably” valued firms
5. Severe differences between Intrinsic and Market values should be examined
6. Utilizes present values
B. Popular Valuation Methods Available
1. Discounted Dividends
2. Discounted Free-Cash Flows
3. The Residual Income Method (accounting based)
4. Abnormal Earnings Approach (accounting based)
5. Long-Run Residual Income Perpetuity
C. Discounted Dividends Valuation
1. The Model

PPS t 

t 1
~


E  d t 1 
1  k 
e
or (in perpetuity)
~


E  d t 1 
PPSt 
r g
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t
BA 3303 (Moore)
Chapter 11 – Valuation
Fall 2006
2. Examine data requirements and estimates
3. Empirical considerations
D. Residual Income Valuation
1. Foundations: Consistent with Modigliani and Miller Model (and intuition)
a. Finance Model (Market Value Based)
VF = VD + VE
(Market Values)
b. Balance Sheet (Accounting Value Based)
A=L+E
(Accounting Values)
2. Residual Income (RI) Valuation Model

VE, t  BVEt 

t0
~
 E ( NI

t  1 )  k e ( BVEt )
 t

1  k 
a. Examine data requirements and estimates
b. Empirical considerations
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e
t 1
BA 3303 (Moore)
Chapter 11 – Valuation
Fall 2006
E. Discounted Free Cash Flows

VE , 0  
E0 FCFt 
t


1

WACC
t 1
AT
1. Examine data requirements and estimates
2. Empirical considerations
3. Difference between accounting earnings and free cash flow (conceptual)
F. Long Run Residual Income (RI) Perpetuity Valuation Model
 ROE  k e 

MVE0  BVE 0  BVE 0 
 ke  g 
This may be stated in either total value or per-share terms.
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