In finance, the discounted cash flow (DCF) analysis is a method of valuing a project, company or asset using the concepts of time value of money (Wikipedia, 2004). Three inputs are required to use the DCF, also called dividend-yield-plus-growth-rate approach, include: the current stock price, the current dividend, and the marginal investor’s expected dividend growth rate. The stock price and the dividend are east to obtain, but the expected growth rate is difficult to estimate (Ehrhardt & Brigham, 2011). The advantages and disadvantages of using DCF approach will be explained along with the further clarification on the cost of capital using DCF approach.

The cost of capital is a term used in the field of financial investment to refer to the cost of a company’s funds, both debt and equity, or from an investors’ point of view, the shareholders required return on a portfolio of a company’s existing securities. It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet (Wikipedia, 2004). In other words, it is the expected return that is required on investments to compensate for the required risk. It represents the discount rate that should be used for capital budgeting calculations. The cost of capital is generally calculated on a weighted average, also called Weighted Average Cost of Capital (WACC). To value of any asset or business is a reflection of the present value of the benefits and liabilities of that asset or business. To use the DCF approach, add the firm’s expected dividend growth rate to its expected dividend yield. See the formula below: Rs=D1/P0 + Expected g

The discounted cash flow approach represents the net present value of project cash flows available to all providers of capital, net of the cash needed to be invested for generating the projected growth. The concept of DCF valuation is based on the...

...Capital Asset Pricing Model (CAPM) Versus the DiscountedCashFlows Method
Managerial Analysis/BUSN 602
Capital asset pricing model or CAPM is a financial model that measures the risk premium inherent in equity investments like common stocks while DiscountedCashFlow or DCF compares the cost of an investment with the present value of future cashflows generated by the investment with the mindset being that if the cashflow is positive, then the investment is good. Generally speaking, CAPM is a model that describes the relationship between risk and expected return and DCF is a valuation method used to estimate the attractiveness of an investment opportunity. So what are the differences, advantages and disadvantages of each one? How do you go about applying them? They each have their own purpose. Let’s first take a look at CAPM.
“CAPM is a model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.”("Capital asset pricing,") It looks at the risk and rates or return and compares them to the stock market. While it is impossible to have no risk, CAPM helps calculate investment risk with the return on investment that is predictable and expected. “The CAPM says that the expected return of a security or a...

...discountedcashflow (DCF
In finance, discountedcashflow (DCF) analysis is a method of valuing a project, company, or asset using the concepts of the time value of money. All future cashflows are estimated and discounted to give their present values (PVs) — the sum of all future cashflows, both incoming and outgoing, is the net present value (NPV), which is taken as the value or price of the cashflows in question.
Using DCF analysis to compute the NPV takes as input cashflows and a discount rate and gives as output a price; the opposite process — taking cashflows and a price and inferring a discount rate, is called the yield.
Discountedcashflow analysis is widely used in investment finance, real estate development, and corporate financial management.
Discount rate
Main article: Discounting
The most widely used method of discounting is exponential discounting, which values future cashflows as "how much money would have to be invested currently, at a given rate of return, to yield the cashflow in future." Other methods of discounting, such as hyperbolic discounting, are studied in academia and said to...

...REEBY SPORTS
Principles of Corporate Finance
7th Edition
Richard A. Brealey and Stewart C. Myers
George Reeby proposes to sell 90,000 shares, or about 22%, of his company. How much are those shares worth? We have to value the company using George's forecasts.
The forecasts presented in Tables 4.10 and 4.11 do not show free cashflow and financing requirements. These are calculated in Table 1. Note that freecashflow for 2005 is -$2.3 million. But dividends are $2.0, so the company will need 2.3 + 2.0 = $4.3 million in outside equity financing.
Table 2 shows that the book value of equity is forecasted to grow from $40.71 million in 2004 to $63.31 million at the end of 2010. Table 3 works out earnings, dividends and free cashflow for 2011. By that time Reeby Sports should be earning 12% on equity, paying out 40% of earnings, and growing steadily at 7.2% per year. Note that gross investment equals depreciation plus 60% of earnings.
s
It's easiest to value the company by assuming that its current shareholders contribute all of the $4.3 million required in 2002 and receive all of the free cashflow afterwards. Note from Table 1 that the present value of free cashflow from 2004 to 2010 is $8 million.
Of course there are several ways to...

...Exam 2 Part 2
Answer any EIGHT of the ten questions. Each question is worth 5 points.
Return your answers to me by 11:59 PM Sunday 11 November 2012
1. A number of publicly traded firms pay no dividends yet investors are willing to buy shares in these firms. How is this possible? Does this violate our basic principle of stock valuation? Explain.
Our basic principle of stock valuation is that the value of a share of stock is simply equal to the present value of all of the expected dividends on the stock. According to the dividend growth model, an asset that has no expected cashflows has a value of zero, so if investors are willing to purchase shares of stock in firms that pay no dividends, they evidently expect that the firms will begin paying dividends at some point in the future.
2. Explain why some bond investors are subject to liquidity risk, default risk, and/or taxability risk. How does each of these risks affect the yield of a bond?
Liquidity problems exist in thinly traded bonds making some bonds difficult to sell at their actual value. Default risk is the likelihood the corporation will default on its bond obligations. Taxability risk reflects the fact that some bonds are taxed disadvantageously compared to others. If any of these risks exist, investors will require compensation by demanding a high yield.
3. The discussion of asset pricing in the text suggests that an investor will be indifferent between two bonds...

...Literature Review of DCF
An important consideration when using the DCF approach to valuation is its validity and usefulness in valuing companies and their stock prices. Various studies have established that a strong correlation between estimated future cashflows and the value of a firm exists (Copeland et al, 1994 ; Brealey and Myers , 2000; Jones, 1998 ).
In their study of 51 highly leveraged transactions (HLTs) , Kaplan and Ruback (1995) found that the valuations using the DCF methods are within 10%, on average, of the market value of the transactions, providing a strong relation between the market value and discountedcashflow forecasts.
In addition, they found that the DCF methods perform at least as well as the comparable valuation methods. Comparing valuations using the Adjusted Present Value (APV) approach to those using comparative valuation methods, 47.1% to 62.2% of the APV valuations had valuation errors within 15%, compared to 37.3% to 57.9% using comparable valuation methods.
Furthermore, after calculating an implied discount rate that forces their DCF forecasts to the market values, they obtained an implied market equity risk premium that is comparable to the historic arithmetic average market equity risk premium, suggesting the accuracy of the DCF method.
Other studies have...

...is cost of capital?
The cost of capital is the cost of obtaining funds, through debt or equity, in order to finance an investment. It is used to evaluate new projects of a company, as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet.
Importance
The concept of cost of capital is a major standard for comparison used in finance decisions. Acceptance or rejection of an investment project depends on the cost that the company has to pay for financing it. Good financial management calls for selection of such projects, which are expected to earn returns, which are higher than the cost of capital. It is therefore, important for the finance manager to calculate the cost of capital, which the company has to pay and compare it with the rate of return, which the project is expected to earn.
In capital expenditure decisions, finance managers go on accepting projects arranged in descending order of rate of return. He stops at the point where the cost of capital equals to the rate of return offered by the project. That is, the finance manager finds out the break-even point of the project. Accepting any project beyond the break-even point will cause financial loss for the...

...MODELING THE DCF Modeling unlevered free cashflows Discounting to reflect stub year and mid-year adjustment Terminal value using growth in perpetuity approach Terminal value using exit multiple approach Calculating net debt Shares outstanding using the treasury stock method Modeling the weighted average cost of capital (WACC) Sensitivity analysisusing data tables Modeling synergies
***************************** SAMPLE PAGES FROM TUTORIAL GUIDE *****************************
DCF in theory and in practice
DCF in theory • The DCF valuation approach is based upon the theory that the value of a business is the sum of its expected future free cashflows, discounted at an appropriate rate. • Discountedcashflow (DCF) analysis is one of the most fundamental, commonly-used valuation methodologies. It is a valuation method developed and supported in academia and also widely used in applied business practices. DCF in practice • There is no consensus on implementation – controversies predominantly over the estimation of the cost of equity. • Extremely sensitive to changes in operating, exit and discount rate assumptions. • That said, there are general rules of thumb that guide implementation. Two-stage DCF model is prevalent...

...ogCost of capital
First of all I would like to say the I wanted to calculate the cost of debt and cost of equity but the information given in the statements are missing the items needed to calculate the cost of debt and the cost of equity but I would like to analyze the information related to this part
The market capitalization already increased in year 2010to 7,016 million from the previous year which was 3,805 million in year2009.also we can see the share price started year2010 with equal to 180,168,300 and ended the year with 143,885,400 this time it’s showing decreasing number not increasing as usual we need to look to the property plant and equipment its percentage increased as it was 69.7% in year 2009 to 70.3% in year 2010,we can have a look to the receivables and prepayments and this was higher in year 2009 with 13% than it was 2010 with 10.4% .the inventories percentage already decreased from year 2009 to 2010 as we see it was 0.2%in year2009 then it became 0.1% .we don’t need to forget about looking to the shareholders equity as it was 3,,641 million in year 2010 and was lower in the year of 2009 with 2,621 million and it was higher in year 2009 than it was in year 2009,the total assets were increased as we see it was 11,398 in year 2009 and it was 13,240 in year 2010 ,when we look to the revenue we can find that it’s as other equities increasing in a great way as it was 3,133million...

1397 Words |
4 Pages

Share this Document

{"hostname":"studymode.com","essaysImgCdnUrl":"\/\/images-study.netdna-ssl.com\/pi\/","useDefaultThumbs":true,"defaultThumbImgs":["\/\/stm-study.netdna-ssl.com\/stm\/images\/placeholders\/default_paper_1.png","\/\/stm-study.netdna-ssl.com\/stm\/images\/placeholders\/default_paper_2.png","\/\/stm-study.netdna-ssl.com\/stm\/images\/placeholders\/default_paper_3.png","\/\/stm-study.netdna-ssl.com\/stm\/images\/placeholders\/default_paper_4.png","\/\/stm-study.netdna-ssl.com\/stm\/images\/placeholders\/default_paper_5.png"],"thumb_default_size":"160x220","thumb_ac_size":"80x110","isPayOrJoin":false,"essayUpload":false,"site_id":1,"autoComplete":false,"isPremiumCountry":false,"userCountryCode":"US","logPixelPath":"\/\/www.smhpix.com\/pixel.gif","tracking_url":"\/\/www.smhpix.com\/pixel.gif","cookies":{"unlimitedBanner":"off"},"essay":{"essayId":35111281,"categoryName":"Periodicals","categoryParentId":"17","currentPage":1,"format":"text","pageMeta":{"text":{"startPage":1,"endPage":3,"pageRange":"1-3","totalPages":3}},"access":"premium","title":"Cost of Capital Using Discounted Cash Flow Approach","additionalIds":[3,9,52,5],"additional":["Business \u0026 Economy","Entertainment","Business \u0026 Economy\/Organizations","Computer Science"],"loadedPages":{"html":[],"text":[1,2,3]}},"user":null,"canonicalUrl":"http:\/\/www.studymode.com\/essays\/Cost-Of-Capital-Using-Discounted-Cash-782485.html","pagesPerLoad":50,"userType":"member_guest","ct":10,"ndocs":"1,500,000","pdocs":"6,000","cc":"10_PERCENT_1MO_AND_6MO","signUpUrl":"https:\/\/www.studymode.com\/signup\/","joinUrl":"https:\/\/www.studymode.com\/join","payPlanUrl":"\/checkout\/pay","upgradeUrl":"\/checkout\/upgrade","freeTrialUrl":"https:\/\/www.studymode.com\/signup\/?redirectUrl=https%3A%2F%2Fwww.studymode.com%2Fcheckout%2Fpay%2Ffree-trial\u0026bypassPaymentPage=1","showModal":"get-access","showModalUrl":"https:\/\/www.studymode.com\/signup\/?redirectUrl=https%3A%2F%2Fwww.studymode.com%2Fjoin","joinFreeUrl":"\/essays\/?newuser=1","siteId":1,"facebook":{"clientId":"306058689489023","version":"v2.8","language":"en_US"},"analytics":{"googleId":"UA-32718321-1"}}