Capital Valuation Paper
A business valuation of a company, especially one the size of Target, is a mystery but is often an integral part of planning, decision-making, strategic assessment, and maybe an equitable resolution to a touchy concern. Knowing what a business is worth and placing a value on it builds confidence so undervalue or overvalue of the business does not happen.
Team C will perform a capital valuation of the retail merchandising chain Target. To obtain the answers needed for the valuation, Team C will justify the current market of Target’s debt and equity by using various capital models of valuation. Team C will provide in-depth calculation of the discoveries and include models with rates of return.
Current Market Price of Target’s Debt
Valuation models are used in investment decisions whether it is a decision on which assets are under or overvalued. When in an efficient market, the market price is the best estimate of value. The purpose of the Discounted Cash Flow valuation model is the justification of the value. In the discounted cash flow valuation, the value of an asset is the present value of the expected cash flows on the asset. The information needed to use the discount cash flow valuation is: estimate of the life of the asset, estimate the cash flows during the life of the asset, and estimate the discount rate applied to these cash flows to obtain a present value (Damodaran, n.d.).
In the Cash Flow valuation, the cash flow in period is t, r is the discount rate appropriate given the riskiness of the cash flow, and t is the life of the asset. Target can have two propositions. Proposition 1: is for an asset to have value, the expected cash flows has to be positive over the life of the asset. Proposition 2: the assets generate cash flows early in life will be worth more than assets that generate cash flows later (Damodaran, n.d.).
Therefore, the current market price of Targets outstanding debt is difficult to obtain directly because debt is in the form of bonds, outstanding market trades, etc. Many firms have non traded debt, which is specified in book value and not in market value terms much of this information is not publicly provided.
Current Market Price of Target’s Equity
Many of the ratios used to evaluate a company can be used to evaluate and justify the current market price of Target’s equity. One valuation model, which is good for evaluating Target’s equity, would be the price per earnings (P/E) ratio, which gauges the quantity in which investors are prepared to give for every dollar of a business’s earnings. An elevated P/E ratio indicates larger investor assurance in the company. The P/E ratio is figured by dividing the market price per share of common stock by earnings per share (Gitman, 2006). Gitman explains “The P/E ratio is most informative when applied in cross-sectional analysis using an industry average P/E ratio or the P/E ratio of a benchmark firm” (p. 70). Targets industry is categorized as discount variety stores, and includes 12 other companies (YCharts, 2010).
Although the P/E ratio is good for comparing a company with other companies in the industry, the main valuation model for evaluation the value of common stock is the basic common stock valuation model, which seeks to determine “the value of a share of common stock is equal to the present value of all future cash flows (dividends) which is expected to provide over an infinite time horizon” (Gitman, 2006, p. 342). The variables in the basic common stock valuation model are worth of the common stock, per share dividend accepted at the end of a specified year, and obligatory return on common stock (Gitman, 2006).
Sometimes a firm has no history of paying dividends, so the basic common stock valuation model will not work. In this case, the free cash flow valuation model can be used to...