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Outline
Process of Valuation of a Financial Asset Process of Valuation of Common Stocks Determining parameters of models
How to determine the growth rate? Length of growth period How to determine the required rate of return Dividend Discount Models Price-Earnings Models Free Cash Flow to Equity Valuation Models
Two-Stage DDM
In general version of the model, two stages of growth
An initial period of extraordinary growth After initial period, a period of stable growth n DPSt Pn
P0 = ---------- + ---------
1% higher than stable No high growth 1 10% higher than stable 5 years > 10% higher than stable 10 years
FCFE = Net Income + Depreciation Capital Spending - Working Capital Principal Repayments + New Debt Issues If there is a target debt ratio, FCFE = Net Income - (1 - )(Capital Expenditure Depreciation) - ( 1- ) Working Capital
FCFE Model
n FCFEt
Pn