FIN 370

University of Phoenix

This paper will justify the current market price of Google’s debt and equity, using various capital valuation models. Calculations to support the finding will be detailed, including those involving rates of return. The valuation model that best supports the finding will also be detailed and defended in this paper. Google History

Google is a publically owned company and the shares of Class A common stock are listed on the Nasdaq Stock Market LLC under the symbol GOOG (Yahoo Inc., 2012). Google’s Class B common stock is not publicly traded. Google’s initial public offering was on August 18, 2004 at a price of $85 per share. As of March 15, 2012, Google shares are trading at a staggering $621.13 a share (Yahoo Inc., 2012). Efficient Markets Hypothesis

Because stockholders expect to be compensated for their investment through dividends and capital gains, valuation models are used by potential investors to determine whether assets are overvalued or undervalued. Within an efficient market, the market price is the best estimate of the value or equilibrium price of each share. The efficient market hypothesis states that at any given time share prices reflect all available information (Karz, 2011). If the expected return is greater than the required return, investors will buy shares and the price of the stock will reach a new equilibrium price. If the investors required return is higher than the expected return, investors will sell shares and the price of the stock will reach a new equilibrium price. The expected return is expressed as E(r) = D/P + g, where D is dividend, P is price, and g is expected growth. Valuation Models

Google stock does not pay a dividend and according to Google Investor Relations (2012), the company does not intend on paying dividends in the future. When companies like Google do not issue dividends, investors make money or lose money only when shares are sold. Google Inc. continues to reinvest their profits back into the company and some investors are holding their shares just waiting for the day that Google pays dividends. One possible valuation model is the free cash flow model. The free cash flow model measures how much cash a business generates after accounting for capital expenditures such as buildings or equipment. The formula for free cash flow (FCF) is FCF = Operating Cash Flow - Capital Expenditures. Net cash provided by the operating activities of Goggle Inc., for the second quarter of 2011 totaled $3.52 billion. In the second quarter of 2011, capital expenditures were $917 million. As of the 2nd quarter of 2011, Google Inc. (2012) reported that the company’s free cash flow was $2.60 billion. The price/earnings or PE ratio is another valuation model that could be used to evaluate the current market price of Google’s equity. This model gauges the earnings per share compared to the current price of the stock (Investopedia, 2012). The PE ratio is calculated as: Market Value per Share

Earnings per Share (EPS)

Earnings per share (EPS), is usually calculated over a period of 12 months and is also called the trailing PE ratio. According to Forbes.com (2012), Google’s trailing price/earnings for March 15, 2012 is 20.9. A high PE ratio generally indicates that there is increased demand because investors anticipate earnings growth in the future. The PE ratio has units of years, which can be interpreted as the number of years (20.9) of earnings to pay back purchase price.

Price to Sales (P/S) is another valuation model that can be used to determine the value of Google Inc. When companies are not currently earning money, the P/E approach impossible to use and analysts often estimate the value of stock as a multiple of sales. Yahoo Finance (2012) shows the P/S for Google Inc. as 5.26. This ratio is mainly used when comparing similar companies. Because the P/S ratio does not take expenses...