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CONT.
INCOME STATEMENT OPERATING REVENUE OPERATING EXPENSE ALL YEARS $350 (150) $200 DEPRECIATION EXPENSE OPERATING INCOME BEFORE TAX TAX@ 20% (50) $150 (30)
$120
(20) $100
(ASSUME r= 10%) ( Debt to capital 20% and cost of debt is 8%(after tax))
$350
(150) $200 (50) $150 (30) $120 0.8*Eo = 80 83.2 86.53
New Investments
.2*Eo = $20 20.8 21.63
NET INCOME $100 Using the growth formula to find the value of the firm equity yields NEW INVESTMENT (EQUITY) 20 Po = KEO (1+g)/(r-g) = 0.8(104)/(.10-.04)= AVAILABLE FOR EQUITY HOLDERS $80 $ 1387
$120 (30)
$90
ESTIMATING r*
r*=actual return r= required rate of return when r*=r , growth model reduces to nogrowth case when r*>r , only then growth opportunities exist
Share holders wealth is not affected by firms dividend policy
Payout ratio k 0.75 0.50 0.25 Reinvested Income (1-k)E 25 50 75 Growth rate g=(1-k)r 0.025 0.050 0.075 Share Value P0=kE/(r-g) 75/(0.1-0.025)=$1000 50/(0.1-0.050)=$1000 25/(0.1-0.075)=$1000
For stable growth companies , k and ROE are relatively constant and for cyclical companies they are not.
K= (Dividends + share repurchases new equity issued)/Earnings
Free cash flow has been suggested as, when the valuation objective is the firm. Three of the most used valuation techniques are: (1) Valuing the cash flow to the invested capital (debt + equity), or free cash flow to the firm (FCFF); (2) Valuing the cash flow of the equity holders, or free cash flows to equity (FCFE); (3) Valuing EBITDA (Earnings before interest, taxes, depreciation and amortization).
Free cash flow:Net operating income before replacement of depreciated assets (-) replacement of depreciated assets (-) net investment = free cash flow
This is equivalent to:Adjusted CFO(net operating income plus adjustment) (-) cash from investment (new + replacement) =free cash flow
Note:- the adjusted CFO is not same as CFO reported in the statement of cash flow