Valuation- “projected financial performance into values.” Involves projecting/ making budgets. Value of an Asset = Value of Cash Flow (CF) it Will Generate (not profits) CF=1/(1+r)^1 value is based on three things- Current Cash Flow, Expected growth (used with to estimate future cash flow), Riskiness of expected future cash flow (discount rate).Net Present Value- Value CFs using project discount rate based on risk Investment Decision-which real assets the firm should acquire.Choose positive and greatest NPV.value through CF Financing Decision- how to raise money needed for a firm’s investments in real assets. Choose capital structure to minimize cost of capital, maximize value of the firm. value through the cost of capital Valuation adjustments- Time, Risk, Inflation, LiquidityTruncated cash flows: (Time) receive $CFt each period until time T. Constant discount rate 10%. Investment of $100 in time 0. CFs of $22 in t=1 and $121 in t=2 Annuity: receive $CF each period until time N Perpetuity: receive $CF each period forever Gordon Formula- (perpetuity) for valuing a firm with growing dividends π =risk premium.the risk premium is everything above the risk free rate, r+π = Risk Adjusted Discount Rate (RADR) Nominal rate - Actual rate of return( using actual dollars) rnomial=real+I, Real rate - Rate adjusted for inflation(using constant dollars), i.e. the return in today’s dollars. Balance sheet (a given point of time)and income statement: Firm’s two main financial constructs Income statement-operating performance of the firm over a given time period Cash flow statement- derived from income statement and changes in balance sheet FCF-Free Cash Flow- is cash available to distribute to stockholders and bondholders. Profits already have payments to debt holders subtracted out. Profits are thus cash available for equity holders. FCF represents returns to all financing. Firms are valued by discounting future FCF. FCF includes only the cash available to the firm from its business activities Indirect method- Starts with the firm’s Profit After Tax (PAT) Two types of adjustments. Operating Adjustments: Present result of business activity on a cash basis.(Depreciation, New fixed assets, and Change in NWC). Financial Adjustments: For financial items (Interest expense)Direct method- Starts with Revenues Financial statements are prepared on an accrual basis..Accrue- to accumulate a receivable (asset) or payable (liability) even though no explicit cash transaction has occurred PAT (Profit After Taxes) + Depreciation and amortization and other provisions,- (+) Increase (Decrease) in Accounts Receivable, - (+)Increase (Decrease) in Inventory, +(-) Increase (Decrease) in Accounts Payable, +(-) Increase (Decrease) in Taxes Payable, +(-)After tax interest expense (income)=Cash Flow from Operations (CFO) - Increase in Property, Plant and Equipment =FCF pro-forma profit and loss statements- Use these projected financial statements to calculate future (FCF), Discount the FCF at the appropriate WACC. This gives the value of the firm as a whole (sum of the values of all securities)multiples analysis- Multiple- a ratio of a Price to some other Measure of the firm. M/B ratio and P/E ratio. Used in stock evaluations (IPOs) Same PE implies same pay-out policy, same dividend growth rate and same cost of capital comparable firms by: Industry, Technology, Clientele, Size . DCF Many small assumptions, PE One large assumption Multiples-MV of Equity / BV of Equity, MV of Assets (MV of Equity + BV of Debt) / BV of AssetsCost of capital-refers to the weighted cost of capital - a weighted average cost of financing sources. WACC-The overall cost of capital to the firm CAPM- Measure Return on Equity based on how much risk firms equity has as compared to the market. The computation of an unlevered beta removes the effects of financial leverage. Operating Leverage-magnifies the effect of cyclicality. ratio of fixed costs to variable costs High operating...

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