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Chapter 7
Chapter 7
• we can calculate the value of this infinite sum in three situations: (1)
The free cash flows are constant forever. (2) The FCF grows at a
constant rate forever. (3) The FCF eventually grows at a constant
rate.
• CLAIMS ON VALUE
• For a company that is a going concern, debtholders have the first
claim on value in the sense that interest and scheduled principal
payments must be paid before any preferred or common dividends
can be paid.
Sources of Value and Claims on Value
The estimated intrinsic value of equity is the remaining value after
subtracting the claims of debtholders and preferred stockholders from
the total intrinsic value
The Intrinsic Value per Share of Common Stock
The estimated intrinsic stock price is equal to the intrinsic value of
equity divided by the number of shares:
The Constant Growth Model: Valuation When
Expected Free Cash Flow Grows at a Constant
Rate
as markets mature, competition and market saturation will tend to limit
FCF growth to a constant long-term rate that is approximately equal to
the sum of population growth and inflation
• Estimating the Value of Operations When Expected Growth Is
Constant
• the model only applies if the expected growth rate is constant and is
less than the weighted average cost of capital.
• Second, the constant growth models are calculating the present value
of all future cash flows from t 5 1 to infinity, not from t 5 0 to infinity
• Third, don’t use Equation 7-9 if constant growth doesn’t begin
immediately.
The Multistage Model: Valuation When Expected
Short-Term Free Cash Flow Grows at a Nonconstant
Rate
• Forecast expected free cash flows and calculate the annual growth
rates for each year in the forecast. Continue forecasting additional
years until the growth rate in FCF is expected to become constant.
The last year in the forecast is called the forecast horizon. It is also
called the horizon date
• Because expected growth is constant after the horizon date, you can
apply the constant growth model from the previous section to
estimate the value of operations at the horizon year. This is called the
horizon value, and it is the value of all free cash flows beyond the
horizon discounted back to the horizon
The Multistage Model: Valuation When Expected
Short-Term Free Cash Flow Grows at a
Nonconstant Rate
• Create a time line with the free cash flows for each year up to the
horizon date. The time line should also include the horizon value at
the horizon date. This means there will be two cash flows on the
horizon date, the free cash flow for that year and the previously
calculated horizon value.
• Discount the cash flows in the time line using the weighted average
cost of capital. The result is the estimated value of operations as of t
=0.
The Multistage Model: Valuation When Expected
Short-Term Free Cash Flow Grows at a
Nonconstant Rate
The Multistage Model: Valuation When Expected
Short-Term Free Cash Flow Grows at a
Nonconstant Rate
Rather than finding the total entity value and then determining the residual share that belongs
to common stockholders, we can find the intrinsic price per share more directly for companies
that pay dividends.
Dividend Valuation Models
Expected Dividends as the Basis for Stock Values
What are a shareholder’s expected cash flows?
Valuing a Constant Growth Stock
constant dividend growth model, or the Gordon model,