Valuing the Target Firm

Decoding QR Code JIS X 0510 In Visual Studio .NETUsing Barcode Control SDK for .NET Control to generate, create, read, scan barcode image in Visual Studio .NET applications.

The harmonic average takes an average of the reciprocals and then takes the reciprocal of the average

Create QR-Code In .NET FrameworkUsing Barcode creation for Visual Studio .NET Control to generate, create QR-Code image in Visual Studio .NET applications.

Is a P/E of 8 or 547 the correct average for purposes of computing the firm's value The conventional average (the P/E of 8) tends to weight extreme values higher than is appropriate For example, assume there are 3 comparable firms, 2 with P/Es of 10 and 1 with a P/E of 100 The conventional average P/E is 40

Read QR Code ISO/IEC18004 In .NETUsing Barcode scanner for VS .NET Control to read, scan read, scan image in Visual Studio .NET applications.

It is not obvious that 40 is the correct measure The example could be more extreme by having the P/E of the third firm 10,000 (as might occur if earnings were unusually low for the observed year) The average P/E is

Bar Code Maker In VS .NETUsing Barcode encoder for VS .NET Control to generate, create barcode image in Visual Studio .NET applications.

PRIVATE EQUITY

Recognizing Bar Code In .NET FrameworkUsing Barcode scanner for .NET framework Control to read, scan read, scan image in VS .NET applications.

The 1499 P/E multiplier would seem to be more useful for valuation purposes than the 3,340 P/E multiplier

Create Denso QR Bar Code In Visual C#.NETUsing Barcode printer for VS .NET Control to generate, create QR Code ISO/IEC18004 image in .NET framework applications.

Multipliers: Theoretical Basis

Print QR In .NETUsing Barcode creator for ASP.NET Control to generate, create QR Code image in ASP.NET applications.

The use of the average P/E of comparable firms has the complexities of determining firms that are actually comparable and computing the average P/E An alternative approach is to compute a theoretical target P/E based on the firm's economic characteristics We will consider three different multipliers, all of which will be used to compute the value of the stock M0 applied to after-tax earnings: M0(E) M1 applied to earnings before interest and taxes: M1(EBIT) M2 applied to earnings before interest, taxes, depreciation, and amortization: M2(EBITDA)

Encode QR Code ISO/IEC18004 In VB.NETUsing Barcode creator for .NET framework Control to generate, create Denso QR Bar Code image in .NET applications.

Determination of M0 Let P be the value now of a share of common stock Then by definition of M0:

Encode Bar Code In Visual Studio .NETUsing Barcode generator for .NET Control to generate, create bar code image in VS .NET applications.

P = M0E

Barcode Printer In VS .NETUsing Barcode maker for .NET framework Control to generate, create barcode image in Visual Studio .NET applications.

Valuing the Target Firm

Making UPC-A Supplement 2 In VS .NETUsing Barcode generator for .NET Control to generate, create UCC - 12 image in VS .NET applications.

14 ________________________________________________________PRIVATE EQUITY

Bookland EAN Creation In .NETUsing Barcode encoder for .NET framework Control to generate, create International Standard Book Number image in VS .NET applications.

Valuing the Target Firm

Code 3/9 Generation In VS .NETUsing Barcode drawer for ASP.NET Control to generate, create USS Code 39 image in ASP.NET applications.

Remember the above example assumes zero debt With outstanding debt the formulation becomes more complex The above multipliers cannot be applied to a different firm with a different cost of equity and a different growth rate The multipliers were computed based on specific information, and other information will lead to different multipliers Since all the above measures are based on objective measures of earnings, EBIT and EBITDA, they appear to be objective, but in fact all the calculations have a significant subjective input However, the appearance of objectivity makes them popular methods of valuation Since all the methods are implicitly assuming future benefits, it is sensible to also compute the present value of these benefits

Decoding USS Code 128 In .NETUsing Barcode decoder for .NET Control to read, scan read, scan image in VS .NET applications.

MEASURES OF PRESENT VALUE __________

USS Code 39 Recognizer In VS .NETUsing Barcode scanner for VS .NET Control to read, scan read, scan image in VS .NET applications.

We consider six different present value calculations that are actually all equivalent, thus are actually one method: 1 Present value of future dividends for perpetuity 2 Present value of discretionary (free) cash flows

Decode European Article Number 13 In .NET FrameworkUsing Barcode decoder for .NET framework Control to read, scan read, scan image in VS .NET applications.

16 _________________________________________________ PRIVATE EQUITY

Paint Barcode In JavaUsing Barcode creator for Java Control to generate, create bar code image in Java applications.

3 Present value of future earnings minus the present value of new investments 4 Present value of an earnings perpetuity plus the present value of growth opportunities (PVGO) 5 Present value of dividends for n years plus present value of the firm's value at time n 6 Present value of economic incomes For the infinite life situation with the firm earning $65 and paying $39 of dividends, a 12 cost of equity and a 02 growth rate, the value is:

Read Bar Code In .NET FrameworkUsing Barcode decoder for .NET Control to read, scan read, scan image in .NET framework applications.

The firm is retaining 4 of earnings and has a growth rate of 02 This implies that incremental investments earn 05 Since 05 is less than the cost of equity, the undertaking of the growth opportunities actually reduces value Instead of assuming one growth rate for perpetuity one could assume a series of changing growth rates The calculations and formulations are more complex, but the logic is perfectly consistent with the infinite life and one growth rate model

Code 3 Of 9 Generation In JavaUsing Barcode generator for Java Control to generate, create Code 39 Full ASCII image in Java applications.

Valuing the Target Firm

Encoding ANSI/AIM Code 128 In Visual C#.NETUsing Barcode maker for .NET Control to generate, create Code 128 Code Set A image in .NET framework applications.

Reinvestment Rate Greater than the Cost of Equity

Now assume all facts are the same except the firm earns 15 on new investments and has a 06 growth rate (4 of earnings are retained)

= $650

Finite Life Models

18 ________________________________________________________PRIVATE EQUITY

For simplification assume there are no taxes Assume the four balance sheets are as shown in Table 21 The economic incomes for the three years are as shown in Table 22 PV (10) = -$18,154 (PV of economic incomes) PV of residual value = 66,555(110)-3 = 50,000 PV of terminal book value = 73,000(110)-3 = 54,846 The firm's value is: V0 = book value + PV of incomes + PV of residual value - PV of terminal book value V0 = 100,000 18,154 + 50,000 - 54,846 = $77,000 The present values of the economic incomes plus the initial book value plus the present value of the residual value minus the present value of the terminal book value is equal to the firm's value at time 0 The amount is also equal to the present value of the cash flows