EQUITY VALUATION
Claims on Cash Flows of Firm
 Investors forego consumption and invest expecting
future returns
 Risk is associated with the investment
 Investors are differ in their Risk/return tolerance
 Priority on claims to cash flows in the case of bankruptcy
Claims in Bankruptcy
1. Administrative expenses related to bankruptcy
2. Expenses after filing and before assignment of Trusted
3. Wages, Salaries, Commissions
4. Contribution to employee benefit plan
5. Consumer claim
6. Government Tax claims
7. Payment to unsecured creditors
8. Payment to preferred stock holders
9. Payment to common stock holders
Scope of Equity Valuation
Valuation is the estimation of an asset’s value.
 Equity valuation can be used in a number of ways
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Stock Selection
Inferring market expectation
Evaluation of corporate events
Evaluating business strategies and models
Appraising private business
Valuation Process
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Understanding the business
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Forecasting Performance
Selecting Valuation model
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Understanding Business
Industry size and growth potential
 Recent development in industry
 Overall supply demand balance
 Qualitative factors including legal and regulatory
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Valuation Methods
 Valuation by Comparison
 Dividend Discount Model
 Constant Growth Dividend Discount Model
 Life Cycles and Multistage Growth Models
 Price-Earnings Ratio
 Free Cash Flow Valuation
Valuation by Comparison
 Value of the firm is estimated by comparing
some elements of the financial statements of the
company with other firms in the same industry
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Price to Earnings (P/E ratio)
Price to Book Value
Price to Sales
(Price to Earning)/Growth Rate (PEG)
 Book Value uses historical numbers and includes depreciation
 Liquidation Value
 Replacement cost
 Tobin q = Market Value/Replacement cost (mainly of
interest to economists)
Dividend Discount Model
 Assume one year holding period
 Let P1 be value at end of investment horizon
 Let D1 be Dividend
 P0 = (D1 + P1)/(1+k)
 k = Market Capitalization Rate
 CAPM
 P1 = (D2 + P2)/(1+k)
 P0 = D1/(1+k) + (D1 + P1)/(1+k)2
 …….
Scope of Equity Valuation
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