Pricing Financial Assets – Equity Valuation
1. Multi-Stage Model – V0 = D11 + k + D2(1 + k)2 + … + DH + PH (1 + k)H ABC pays current D of $1 and is expected to grow at 20% for 2 years, then 4% thereafter. If required return is 8.5% Intrinsic value = $1 × 1.21 + 0.085 + $1 × 1.22(1 + 0.085)2 + $1 × 1.22 × 1.04(0.085 － 0.04) × (1 + 0.085)2 = $30.60. (1) | (2) | (3) | (4) | (5) | Time until Payment (Years) | Payment | Payment Discounted at 6% | Weight | (1)× (4) | 1 | 60 | 56.60 | 0.0566 | 0.0566 | 2 | 60 | 53.40 | 0.0534 | 0.1068 | 3 | 1060 | 890.00 | 0.8900 | 2.6700 | Column Sum: | 1000.00 | 1.0000 | 2.8334 |
2. Expected HPR= E(r) =E(d1)+[EP1-P0]P0 3. DDM- Constant growth DDM: P0 = D1k - g e.g. ABC pays annual D of $1.22, expected to grow indefinitely at 5% Q: If current value based on constant growth is $32.03, what is required rate of return? $32.03 = $1.22 × 1.05k - 0.05 k = 0.089994 or 8.9994% >Market Capitalization Rate (1) | (2) | (3) | (4) | (5) | Time until Payment (Years) | Payment | Payment Discounted at 10% | Weight | (1)×(4) | 1 | 60 | 54.55 | 0.0606 | 0.0606 | 2 | 60 | 49.59 | 0.0551 | 0.1101 | 3 | 1060 | 796.39 | 0.8844 | 2.6531 | Column Sum: | 900.53 | 1.0000 | 2.8238 |
= k = rf + β [E(rM) – rf ] - The Market consensus estimate of the appropriate discount rate for a firm’s cash flows ∴ 3b. Constant growth no K – Step 1. Find market capitalization rate using CAPM = 0.04 + 0.75 (0.12 – 0.04) = 0.10 Step 2. V0 = D1k － g = $40.10 － 0.04 = $66.67. growth =g = ROE b, where b = plowback ratio and ROE = the rate at which income was generated. 4. Present Value Growth Opportunities – Net present value of a firm’s future investments. E.g. ABC expects to earn $6 per share next year, ROE = 15%, plowback is 60%, market capitalization is 10%. Q: What is PVGO? A: Step 1.