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Lecture 15

FIN 302 Lecture 15: Lecture 15

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University of Michigan - Ann Arbor
FIN 302
Denis Sosyura

SESSION 15: STOCK VALUATION - PART 1 Today is all about what Investment Banking Analysts do - Stock basics: key terminology - Discounted Cash Flow valuation (DCF) - Interactive in-class practice STOCK BASICS Stock - a share of ownership in the firm, which entitles the owner to: - Receive dividends - Residual payments - the shareholders are paid last after all debts are paid back (bank loans and bonds) - Vote at stockholders’ meetings on key issues - Request financial information from the company Dividend - distribution of company’s profits to shareholders - Regular dividend - scheduled dividend paid every quarter - Special dividend - one-time distribution of cash to shareholders DISCOUNTED CASH FLOW (DCF) Rationale: company’s value is derived from a forecast of future free cash flows (FCFs) generated by the firm - Discounted value of future cash flows - Step By Step Methodology: 1. Project FCFs in explicit forecast (5-7 years) 1.1. The usual staple is 5 years, 1.2. Value the total future cash flows 2. Estimate Terminal Value (TV) at the end of the explicit forecast 2.1. Usually estimates as a perpetuity, after the explicit forecast period (years past year 5) 2.2. We assume the companies will last forever 2.3. Value of all future cash flows after the explicit forecast period 3. Value of operating assets (VOA) = PV(FCFs) + PV (TV) 3.1. Operating Assets - cash flows from operating activities 4. Enterprise value (EV) = VOA + market value of non-operating assets (financial securities, excess cash, collection of paintings) 4.1. Enterprise Value - VOA - general explicit operating cash flows 4.2. Value of the companies that produce the actual assets 4.3. Non-operating assets 4.3.1. Collections of painting from the city of Detroit was non- operating, but important for the Detroit bankruptcy 4.3.2. Lehman Brothers - portfolios and securities They must be included because they are not included with the FCFs 5. Value of equity = EV - market value of debt 5.1. Value of Equity - subtract the MV of debt (exactly how much it takes off to payoff all of the bondholders) 6. Price per share = (value of equity)/(shares outstanding) 6.1. Price per Share - intrinsic value (valuation by DCF) will show if the stock is under or overvalued 6.2. This is what the analysts do FREE CASH FLOWS (FCF) FOR A COMPANY Revenue - Cost of Goods Sold (COGS) - Expenses (R&D, SG&A, and other expenses) - Depreciation & Amortization = EBIT (Earnings Before Interest and Taxes) - Taxes on EBIT (=EBIT * tax rate) + Depreciation - Capital Expenditures - Increases in NWC (+ decreases in NWC) = FCF EXAMPLE 1: CHIPOTLE DCF VALUATION Find the stock price ●
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