NÁRODNÁ BANKA SLOVENSKA
USING OF THE ECONOMIC VALUE ADDED MODEL FOR VALUATION OF A COMPANY
Doc. Ing. Eva Kislingerová, CSc. Prague University of Economics
Introduction
There is possibility to use, with respect to the object of valuation, several methods for valuation of a company in practice. One of the most important and highly used group of methods are yield methods. They are usually called Discounted Cash Flows (DCF) methods. Value of a company is derived from present value of future incomes connected with the ownership of a company. The core of these models is working with time value of future incomes investor gets in case of realization of an investment. There are several possibilities to work with future incomes in DCF
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This is a basic idea of new measure – EVA. It was first published by Shawn Tully in the Fortune magazine in an article „The Real Key to Creating Wealth“. The broad publicity and success of EVA is result of work of a consulting company Stern Stewart management Services.
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BIATEC, roãník 8, 11/2000
NÁRODNÁ BANKA SLOVENSKA
Figure 1 Definition of Weighted Average Cost of Capital (WACC) Interest for external capital provided re Risk-free rate rf β Stock beta re = rf + β(rm – rf) (rm – rf) Risk market premium RMP (E = Equity)
vide value of equity by number of shares we get value of a share, too. Sample Entering data: set the value of ALFA, Ltd. to the Dec. 31, 1998 if you know following data: a) Information from the balance sheet:
Debt (D) Equity (E) Long Term Invested Capital (C) 55 mil. Kã ⇒ D/C = 0.29 134 mil. Kã ⇒ E/C = 0.71 189 mil. Kã ⇒ Σ = 1.00 15 % 35 % 15(1 – 0.35) = 9.75 %
b) After – Tax Debt Cost
Income Tax Rate t D = Debt Cost of External Capital rd Income Tax Rate (t)x100 Effective Cost of Debt rd
c) Cost of Internal Capital
Weighted Average Cost of Capital D E WACC = rd(1 – t) –– + re –– C C Cost of Internal Capital re (CAPM2 model) 18.,42% = 10.5 + (1.1 x
Debt to Equity ℎℎ ′ 9,771+1,885 Dividend Payout Inventory Turnover = 0.069 Working backwards from the income tax expense, we estimate income tax rate to be 34%. NOPAT is then Operating profit taxes, or 3,137*(1-0.34) = 0.319 Average
Before moving forward to compute the present value of these cash flows, a terminal value is required to forecast the long term value of the company after 5 years. . Following formula is used to calculate the terminal value.
The weighted average cost of capital is the rate that a company is expected to pay on average to all its security holders to finance its assets.
To relever the βe, we use the formula, βe = βu +(D/E)*(βu-βd). And the “Target D/E” was found by taking “Target D/V” divided by “1-Target D/V”. So we get the new βe, 1.3576. Then to get cost of equity, we use the CAPM formula, Re=Rf+β(EMRP), 11.7679%. Since we have get the cost of equity and cost of debt, we can determined the WACC, which is equal to Equity/Value*Cost of Equity+Debt/Value*Cost of Debt*(1-tax rate). In the end ,we arrived at 8.48%.
11. What is the Cost of Equity? ke = Risk Free Rate + (Beta X Risk Premium of 7.5% points). .03 + (.99 x .075) = 10.43%.
10. What is the correct capital structure and weighted average cost of capital for discounting the investment’s free cash flow. Assume a 35% tax rate. A correct response requires that you define capital structure and Weighted Average Cost of Capital (WACC) with a formula. When defining a term with a formula be sure that all the variables are also defined.
The comptroller currently finds the weights for the weighted average cost of capital (WACC) from information from the balance sheet shown in Table 2. Compute the book value weights that the comptroller currently uses for the company’s capital structure.
Given these approximations, the CAPM model would total the risk-free rate and the market risk premium times beta to arrive at a cost of equity of 9.68%, which reflects the investors’ expected return from investing in shares of the company.
- Merlo, Inc. maintains a debt-equity ratio of 0.25 and follows a residual dividend policy. The company has after-tax earnings of $3,800 for the year and needs $3,200 for new investments. What is the total amount Merlo will pay out in dividends this year?If debt = 0.25 and equity = 1, then debt + equity = 1.25. Equity portion of new investments = $3,200 × (1 / 1.25) = $2,560.00
1. Determine the Weighted Average Cost of Capital (WACC) based on using retained earnings in the capital structure.
This case attempts to tackle two approaches in real asset valuation: Discounted Cash Flow (DCF) analysis and the issues surrounding such, as well as the Black-Scholes
Moreover, let’s calculate the Weighted Average Cost of Capital (WACC). And in order to calculate it we need to know the capital structure of the company. Knowing the capital structure of the
Once the prevailing WACC rate was found, the target WACC was calculated to be 9.00%. Again the CAPM model was used but a new the required rate of return on equity needed to be calculated. Since there is a change in the capital structure an unlevered beta needed to be determined. The Hamada equation was used to unlever the beta, which had a debt to equity ratio of .70, then to re-lever it again with a debt to equity ratio of 1.5; this changed the beta from
• Pe = D1/(re – g) = 700 / (0.11 – 0.05) = $11,667 • price per share = $11,667 / 1,000 = $11.67 3. Same facts as (2) above, except the 5% income growth rate (and beginning of year common equity to support it) are only expected for years 2 and 3. Then growth is expected to be zero and all income is expected to be distributed to shareholders for all future years. a. Compute D1, D2, D3, and Dt for all future years. • Keeping in mind that income is $1,100 in year 1, increases by 5% in years 2 and 3, and then remains constant for all future years; and keeping in mind that beginning of year 1 common equity is $8,000, increases by 5% at the beginning of year 2 and at the beginning of year 3, but does not increase at the beginning of year 4 and remains constant from that point forward, you should be able to compute: D1 = $700, D2 = $735, and Dt = 1,212.75 for D3 and all future years. b. Use the dividend discount (i.e., free cash flow to equity investors) valuation model to estimate the company’s current stock price. Pe = 700/(1+ 0.11) + 735/(1+ 0.11)2 + [1,212.75/0.11]/(1+ 0.11)2 = $10,175.31 and the price per share of common stock = $10,175.31 / 1,000 = $10.18. 4. Same facts as (3) above, except the growth rates are 5% for years 2 and 3 and then 3% perpetually for all future years. a. Compute D1, D2, D3 and the growth in D for all future years. • Keeping in mind that income is $1,100 in year 1, increases by 5% in years 2
WACC = (1-corporate tax rate)(Pretax rate of cost of debt)(Market value of debt/ D+E))+ After tax rate of cost of equity(market value of equity/D+E))