Corporate Finance: Laurence Booth - W. Sean Cleary Chapter 7 - Equity Valuation

Prepared by
Ken Hartviksen

INTRODUCTION TO
CORPORATE FINANCE
Laurence Booth W. Sean Cleary

Chapter 7 Equity Valuation
CHAPTER 7
Equity Valuation
CHAPTER 7 Equity Valuation 7 - 3
Lecture Agenda
Learning Objectives
Important Terms
The Nature of Equity Securities
Valuation of Equities
Preferred Share Valuation
Dividend Discount Model
Using Multiples to Value Shares
Summary and Conclusions
Concept Review Questions
Learning Objectives
Understand the basic characteristics of
equity securities
How these securities are valued
Some of the major factors that affect
stock prices
Understand the sensitivity of the
valuation estimate to the input values
used
How to relate valuation models to
commonly used ratios or multiples
Important Chapter Terms
Common share
Constant growth DDM
Dividend discount model
Equity securities
Market value to EBIT ratio
Market value to EBITDA
ratio
Market-to-book ratio
Preferred share
Price-earnings ratio
Price-to-cash-flow ratio
Price-to-sales ratio
Relative valuation
Sustainable growth rate
The Nature of Equities
Equity Valuation
Equity Securities
Introduction
Equities represent ownership claims on businesses
Despite having residual claims to earnings after tax
and to assets upon dissolution equities offer the
prospect for participation in the growth and
profitability of the business.
Equity securities can be valued based on
approaches using the present value of expected
future dividend stream.
Equity Securities
Nature of these Securities
Equity Securities
Include preferred and common shares
Represent ownership claims on the underlying entity
Usually have no specified maturity date, and since the
underlying entity has a life separate and apart from
its owners, equities are treated as investments with
infinite life
Equities may pay dividends from after-tax earnings at
the discretion of the board of directors
Equity Securities
Common Shares
According to the Canada Business Corporations Act (CBCA)
corporations must have at least one share class with the
following rights:
Rights to residual earnings after-tax (after all legal obligations to
other claimants have been satisfied)
Rights to residual assets upon dissolution/liquidation
Exert control over the corporation through voting rights to elect
board of directors, accept financial statements, appoint auditors
and approve major issues such as takeovers and corporate
restructuring.
Equities with the foregoing characteristics are typically called
Common Shares
Equity Securities
Preferred Shares
Have some preference over the common share class
Usually have the following characteristics:

A fixed annual dividend (not legally enforceable by shareholders
if not declared)
Have prior claim to dividends and assets upon
dissolution/liquidation over and above the common shares
Non-voting except if dividends are seriously in arrears
No maturity date
Often have a cumulative feature (dividends in arrears must be
paid before common shareholders can receive dividends)
Often called a fixed income investment because the regular
annual dividend is fixed (set) at the time the shares are originally
issued.

Valuation of Equities
Equity Valuation
Valuation of Equity Securities
Risk-Premium Approach
Valuation of equities can follow a discounted cash
flow approach
The discount rate used reflects current level of
interest rates (based on the risk-free rate) plus a risk
premium
This relationship is expressed as:
Premium Risk RF+ = k
[ 7-1]
Valuation of Equity Securities
Risk-Premium Approach

The risk-free rate is
equal to the real rate of
return plus expected
inflation (Fisher
Equation)
The risk premium is
based on an estimate of
the risk associated with
the security.
Equation 7-1 can be
described graphically as
follows:
Premium Risk RF+ = k [ 7-1]
Risk of Equity
Security M
Required
Return (%)
RF
Risk
Required
return on
Equity
Security (M)
Risk
Premium
Real Return
Expected Inflation Rate
Equity Valuation
Cash Flow Pattern for a Straight Preferred Share

0 1 2 3
D
p
D
p
D
p
D
p
D
p

7-1 FIGURE
Preferred shares can be viewed as perpetuities because of the
nature of the dividend stream they offer.
A perpetuity is an infinite series of equal and periodic cash flows.
Value of a Perpetuity
P
ps
is the market price (or present value)
D
p
is the annual dividend amount
k
p
is the required rate of return investors demand (or discount rate)
p
p
ps
k
D
P =
[ 7-2]
Determine the market price of a $100 par value preferred share
that pays dividend based on a 7 percent dividend rate when
investors require a return of 10 percent on the investment.

What happens to the market price if interest rates rise and
investors now require a 12 percent rate of return on the
investment?
Value of a Perpetuity - Example
00 . 70 $
10 . 0
00 . 7 $
10 . 0
100 $ 07 .
= =
= =
p
p
ps
k
D
P
[ 7-2]
33 . 58 $
12 . 0
00 . 7 $
12 . 0
100 $ 07 .
= =
= =
p
p
ps
k
D
P
[ 7-2]
What happens to the market price if interest rates fall and
investors now require a 7 percent rate of return on the
investment?

Like bonds, when the required return is equal to the preferred
dividend rate, the preferred will be priced to equal its par value.
Value of a Perpetuity Example
00 . 100 $
07 . 0
00 . 7 $
07 . 0
100 $ 07 .
= =
= =
p
p
ps
k
D
P
[ 7-2]
The preferred share valuation equation can be modified to solve
for the investors required rate of return.

Remember, for market traded preferred shares, the stock price
will be observable (known) and so too will the annual dividend,
so this type of calculation is very common.

Estimating the Required Rate of Return

ps
p
p
P
D
k =
[ 7-3]

Assuming the previous 7%, $100 par value preferred share is
currently trading for $57.25, what is the implied market-
demanded required return?

You knew that the share was trading for less than its par value,
so even before trying to solve for the answer, you should have
known that investors were requiring a higher rate of return than
7%.
Estimating the Required Rate of Return An Example
% 22 . 12
25 . 57 $
00 . 7 $
25 . 57 $
100 $ 07 .
= =
= =
ps
p
p
P
D
k
[ 7-3]
Valuation of Common Stock
Equity Valuation
Common Share Valuation
Discount Models
All discount valuation models estimate the current economic value of
any security as the sum of the discounted (present) value of all
promised future cash flows.

The current value is therefore a function of the timing, magnitude and
riskiness of all future cash flows:

=
+
=
+
+ +
+
+
+
=
n
i
i
i
n
n
k
Flow Cash
k
Flow Cash
k
Flow Cash
k
Flow Cash
V
1
2
2
1
1
0
) 1 (

) 1 (
...
) 1 ( ) 1 (
Discount Models
In the case of common stock the cash flows of a going-concern
business are expected to go on in perpetuity (forever).

The purchaser exchanges the price she/he paid for the investment at
time 0 with a possible series of future cash flows.

Risk is factored into the equation through k (investors required return)
=
+
=
+
+ +
+
+
+
=
o
o
o
1
2
2
1
1
0
) 1 (

) 1 (
...
) 1 ( ) 1 (
i
i
i
k
Flow Cash
k
Flow Cash
k
Flow Cash
k
Flow Cash
V
Discount Models

The formula can be illustrated graphically as follows:
=
+
=
+
+ +
+
+
+
=
o
o
o
1
2
2
1
1
0
) 1 (

) 1 (
...
) 1 ( ) 1 (
i
i
i
k
Flow Cash
k
Flow Cash
k
Flow Cash
k
Flow Cash
V
V
0
= Market Price Paid $
CF
1
CF
2
CF
3
CF

0
1 2 3
Discount Models

Remember, the amount and timing of future dividends (if that is the
cash flow you are using) is highly uncertain for most businesses
because dividends are not fixed obligation of the firm, but rather are
declared at the discretion of the board of directors, when, and if the firm
is profitable, and doesnt have other uses for the cash.
=
+
=
+
+ +
+
+
+
=
o
o
o
1
2
2
1
1
0
) 1 (

) 1 (
...
) 1 ( ) 1 (
i
i
i
k
Flow Cash
k
Flow Cash
k
Flow Cash
k
Flow Cash
V
Common Share Valuation using DDM
The Basic Dividend Discount Model Intrinsic Value Estimate

The DDM says the intrinsic value or inherent
economic worth of the stock is equal to the sum of the
present value of all future dividends to be received.
n
c
n
c c
k
D
k
D
k
D
P
) 1 (
...
) 1 ( ) 1 (
2
2
1
1
0
+
+ +
+
+
+
=
[ 7-4]
Fundamental Analysts and the Basic Dividend Discount Model
Security analysts that use the DDM model are called
FUNDAMENTAL ANALYSTS because they base the estimate of
inherent worth on the economic fundamentals of the stock.

Once they have estimated the inherent worth, they compare their
estimate with the actual stock price in the market to determine
whether the stock is UNDER, OVER, or FAIRLY valued.
=
+
=
+
+ +
+
+
+
=
o
o
o
1
2
2
1
1
0
) 1 ( ) 1 (
...
) 1 ( ) 1 (
t
t
c
t
c c c
k
D
k
D
k
D
k
D
P
[ 7-5]
The Constant Growth DDM
When the firms dividends are growing at a slow, constant rate,
and reasonably can be expected to do so for the foreseeable
future, we use the constant growth dividend discount model.

Which can be simplified by multiplying D
0
by a factor of
(1+g)/(1+k
c
) every period to get:
o
o
) 1 (
) 1 (
...
) 1 (
) 1 (
) 1 (
) 1 (
0
2
2
0
1
1
0
0
c c c
k
g D
k
g D
k
g D
P
+
+
+ +
+
+
+
+
+
= [ 7-6]
g k
D
g k
g D
P
c c

=
+
=
1 0
0
) 1 (
[ 7-7]
Estimating the Required Rate of Return
The Constant Growth DDM can be reorganized to solve for the
investors required return

This formula can be decomposed into two components,
demonstrating that equity investors receive two forms of prospective
income from their investment, dividends and capital gains.
g
P
D
k
c
+ =
0
1
[ 7-8]
| | | | | | Yield Gain Capital Yield Dividend Current

0
1
+ = +
(
= g
P
D
k
c
Estimating the Value of Growth Opportunities
Assuming the firm has no profitable growth opportunities g should be
equal to 0, and D
1
=EPS
1

The Constant Growth DDM reduces to:

Therefore, the share price of any constant growth common stock is
made up of two components:
The no-growth components and
The present value of growth opportunities

This can be expressed as:

(See the following slide)
c
k
EPS
P
1
0
=
[ 7-9]
Constant Growth DDM Two Components
Estimating the Value of Growth Opportunities

Decomposing the constant-growth DDM into its two
components gives us an analytical tool to examine the two
sources of current value of the firm.
| | | | ies opportunit growth of value present component growth no
PVGO
k
EPS
P
c
+ =
+ =
1
0
[ 7-10]
Examining the Importance of the Growth Assumption

The formula assumes that the growth rate will remain the same in period 1
through infinity.
This is a very long period of time
It assumes a compound growth rate
...
3 2 1 o
g g g g = = = =
g k
D
P
c

=
1
0
[ 7-7]
Time
Earnings
5% growth
rate

Examining the Importance of the Growth Assumption

The formula assumes that the growth rate will remain the same
in period 1 through infinity.
This is a very long period of time
Because of compounding over time, small changes in g will have
dramatic effects on the estimated stock value today.
If g is assumed to be greater than k
c
a non-sense answer would
result. In practice this could never happen because no company
can continue to grow at compound rates of return to infinity at a rate
that exceeds the long-term rate of growth in the economy.
g k
D
P
c

=
1
0
[ 7-7]
Examining the Inputs of the Constant Growth DDM

The formula predicts stock price increases if:
D
1
is increased
g is increased
k
c
is decreased
Conversely, the formula predicts stock price increases if:
D
1
is decreased
g is decreased
k
c
is increased

g k
D
P
c

=
1
0
[ 7-7]
Estimating DDM Inputs Sustainable Growth
Sustainable growth can be estimated using the following
equation:

Where: b = the firms earnings retention ratio
= (1 firms dividend payout ratio)
and

ROE = firms return on common equity
= net profit/common equity

ROE b g =
[ 7-11]
Clearly, the value of the firm will rise if the firm retains and
reinvests its profits at a rate of return (ROE) greater than k
c
Under such conditions, g increases more than k
c
Estimating DDM Inputs Sustainable Growth

Decomposing ROE using the DuPont system allows managers
to see how they can increase the value of the firm:
increase the profit margin on sales
Increase the turnover rate on sales
Leverage the firm using less equity and more debt (although use of
more debt implies higher risk and the benefits may be offset by a higher
k
c
)

ROE b g =
[ 7-11]
Ratio Leverage Ratio Turnover Margin Profit Net
Equity
Assets Total
Assets Total
Sales

Sales
income Net
ROE
=
=
[ 7-12]
The Multiple Stage Growth Version of the DDM
Firms with earnings that
are growing rapidly (more
rapid than the general rate
of economic expansion)
require another approach.
Remember, no firms
growth in earnings can
exceed the general rate of
economic expansion
foreverat some point,
earnings growth will fall.
...
5 4 3 2 1 o
g g g g g g = = = = > >
Time
Earnings
g
1
= 50%
g
2
= 30%
g
3
= g
4
= g
=4%
Multiple Stage Growth Version of DDM
The Cash Flow Pattern for Multiple Stage Growth in Dividends
t
c
t t
c c
k
P D
k
D
k
D
P
) 1 (
...
) 1 ( ) 1 (
2
2
1
1
0
+
+
+ +
+
+
+
=
[ 7-13]
7-2 FIGURE

0 1 2 t t +1

D
1
D
2
D
t
D
t+1

Growth rate long-term growth rate (g) Growth rate = g from t to
g k
D
P
c
t
t
=
+1
Multiple Stage Growth Version of DDM
Using Multiple Stage Growth Version of the DDM
Predict each dividend during the high growth years
Predict the first dividend during the constant growth years
Discount the individual dividends to the present and sum together with
the price at time t when the constant growth model is used.

The following is the formula you would use for two years of high
earnings growth followed by a constant growth in years three through
infinity.
2
2
2
2
1
1
2
3 2 1 0
2
2 1 0
1
1 0
0
) 1 ( ) 1 ( ) 1 (
) 1 (
) 1 )( 1 )( 1 (
) 1 (
) 1 )( 1 (
) 1 (
) 1 (
c c c
c
c
c c
k
P
k
D
k
D
k
g k
g g g D
k
g g D
k
g D
P
+
+
+
+
+
=
+
+ + +
+
+
+ +
+
+
+
=
Example of Two-stage DDM
Using a Spreadsheet Modeling Approach

Forecast Assumptions:
Investors required return = k = 10.9%
Most recent dividend per share = D
0
= $0.25
Growth rate in first year = g
1
=14.8%
Growth rate in second year= g
2
= 10%
Growth rate in years three through infinity = g
3-
= 5%
Time
Dividend / Price
Calculation
Dividend
/Price
Present
Value
Factor
Present
Value
1 $0.25 X (1+.148) = $0.29 0.901713 $0.26
2 $0.287 X (1+.1) = $0.32 0.813087 $0.26
2 P(2) = D(3)/ (.109 - .05) = $5.62 0.813087 $4.57
Intrinsic Value Estimate = $5.08
08 . 5 $
) 109 . 1 (
62 . 5 $
) 109 . 1 (
32 . 0 $
) 109 . 1 (
29 . 0 $
) 109 . 1 (
05 . 109 .
) 05 . 1 )( 1 . 1 )( 148 . 1 ( 25 . 0 $
) 109 . 1 (
) 1 . 1 )( 148 . 1 ( 25 . 0 $
) 109 . 1 (
) 148 . 1 ( 25 . 0 $
) 1 ( ) 1 ( ) 1 (
2 2
2 2 1
2
2
2 1
0
= + + =
+

+
+
+
+
=
+
+
+
+
+
=
c c c
k
P
k
D
k
D
P
Constant Growth DDM
Limitations of the DDM
The Model predictions are highly sensitive to changes in
g and k
c

Not helpful in valuing non-dividend paying firms.
g k
D
P
c

=
1
0
[ 7-7]
Constant Growth DDM
Best Application of the Constant Growth DDM
Use of the Model is best suited to:
Firms that pay dividends based on a stable dividend
payout history that are likely to maintain that practice
into the future
Are growing at a steady and sustainable rate.

This model works for large corporations in mature
industries such as banks and utility companies.
Equity Valuation
The Basic Approach
Relative valuation approaches estimate the value of
common shares by comparing market prices of
similar companies, relative to some variable such
as:
Earnings
EBITDA
Cash flow
Book value
Sales
The challenge is finding the right comparator!
The Price-earnings (P/E) Ratio
Also known as the price-earnings multiple
The ratio tells you how many times projected annual earnings (per
share) the share is currently trading

If you buy a company that is trading 10 times projected earnings, it
will take 10 years of those earnings to recover your investment.
If you buy a company trading 100 times projected earnings, it will
take 100 years of those earnings to simply recover your investment
(not including any time value of money or return on your
investment).
1
0
1
1 0
E
P
EPS
ratio P/E Justified EPS Estimated
=
= P
[ 7-13]
P/E Multiples Over Time
Figure 7 3 illustrates the aggregate P/E ratios for the
S&P/TSX from 1956 through 2005.
This figure is based on trailing multiples (ie. Using actual
earnings per share rather than forecast)
The volatility of these aggregate multiples is driven by the
volatility of corporate earnings.
Falling earnings can result in skyrocketing P/E ratios that are not a
reflection of the increasing value of stock (in fact, the market price of
the stock could be falling), but rather, the fact that earnings have
dropped dramatically, in relation to the stock price
This phenomenon should be expected since one years earnings
can fall, but a stock price (according to the DDM approach) is a
function of many years of forecast cash flows

(See Figure 7 -3 on the next slide)
P/E Multiples
The S&P/TSX Composite P/E
7-3 FIGURE
P/E Multiples
Implementing the P/E Ratio Approach
Estimate EPS
1
using:
Historical earnings data
Projected trends
Use of analyst estimates
Estimate justifiable P/E ratio using where appropriate:
Industry average
Range of P/Es
Subjectively adjusted industry averages based on risk
assessment
Obtain corroborating estimates based on:
Economic, industry and company fundamentals, and/or
Relate P/E to the fundamentals in the DDM
P/E Multiples
Relating the P/E Multiple to Fundamentals in the DDM
Given the constant growth DDM

Divide both sides by expected earnings per share, you get Equation
7-15

Notice that D
1
/EPS
1
is the expected dividend payout ratio at time 1.

Equation 7-15 indicates:
The higher the expected payout ratio, the higher the P/E
The higher the expected growth rate, g, the higher the P/E
The higher the required rate of return, k
c
, the lower the P/E
g k
D
P
c

=
1
0
[ 7-7]
g k
EPS
D
E
P
EPS
P
c

= =
1
1
1
0
[ 7-15]
Using P/E Multiples to Value Shares
Limitations of P/E Ratios
P/Es are uninformative when companies have negative (or very
small) earnings
The volatility in earnings creates great volatility in P/Es throughout
the business cycle.

Given the foregoing problems, analysts normally use smoothed or
normalized estimates of earnings for the forecast year, as well as
using a variety of different approaches to develop a range of
potential values for the stock.

(The issues compromising P/Es are illustrated in Table 7 -1 on the following slides)
Examples in the Forest Industry
Company Price 2006
EPS
Forecast
EPS
P/E P/E
Forecast
Yield TSX
Symbol
Abitibi 2.72 -0.30 0.12 nm 22.67 0.00 A
Canfor 11.13 -0.27 0.47 nm 23.68 0.00 CFP
Cascades 11.54 0.71 0.60 16.25 19.23 1.39 CAS
Canfor Pulp 11.56 1.38 1.20 8.38 9.63 7.51 CFX.UN
Catalyst 3.22 -0.07 0.03 nm nm 0.00 CTL
Fraser Papers 7.01 -1.35 -0.41 nm nm 0.00 FPS
International 6.6 0.26 0.53 25.38 12.45 0.00 IFPA
Mercer 9.69 -0.07 0.14 nm 54.35 0.00 MERC
Norbord 8.41 0.74 0.40 10.24 18.95 4.76 NBD
PRT 11.2 0.69 0.70 16.23 16.00 9.38 PRT.UN
SFK Pulp 4.14 0.64 0.82 6.47 5.05 4.19 SFK.UN
Tembec 1.43 -2.00 -1.11 nm nm 0.00 TBC
TimberWest Forest 14.07 0.01 -0.27 nm nm 7.65 TWF.UN
West Fraser Timber 37.45 0.94 2.35 39.84 15.94 1.50 WFT
Note: nm = note meaningf ul
Source: RBC Dominion Securities Inc., Foundations Research Report, September 2006.
Table 7-1 P/E Ratios in the Paper and Forest Products Sector
Large
number
of firms
with
negative
earnings
Company Price 2006
EPS
Forecast
EPS
P/E P/E
Forecast
Yield TSX
Symbol
Abitibi 2.72 -0.30 0.12 nm 22.67 0.00 A
Canfor 11.13 -0.27 0.47 nm 23.68 0.00 CFP
Cascades 11.54 0.71 0.60 16.25 19.23 1.39 CAS
Mercer 9.69 -0.07 0.14 nm 54.35 0.00 MERC
Norbord 8.41 0.74 0.40 10.24 18.95 4.76 NBD
PRT 11.2 0.69 0.70 16.23 16.00 9.38 PRT.UN
SFK Pulp 4.14 0.64 0.82 6.47 5.05 4.19 SFK.UN
Tembec 1.43 -2.00 -1.11 nm nm 0.00 TBC
P/E ratio
is highly
variable
across the
industry
there is no
average
or
consistent
pattern.
Company Price 2006
EPS
Forecast
EPS
P/E P/E
Forecast
Yield TSX
Symbol
Abitibi 2.72 -0.30 0.12 nm 22.67 0.00 A
Canfor 11.13 -0.27 0.47 nm 23.68 0.00 CFP
Cascades 11.54 0.71 0.60 16.25 19.23 1.39 CAS
Mercer 9.69 -0.07 0.14 nm 54.35 0.00 MERC
Norbord 8.41 0.74 0.40 10.24 18.95 4.76 NBD
PRT 11.2 0.69 0.70 16.23 16.00 9.38 PRT.UN
SFK Pulp 4.14 0.64 0.82 6.47 5.05 4.19 SFK.UN
Tembec 1.43 -2.00 -1.11 nm nm 0.00 TBC
Data mixes
normal
corporations
with Income
Trust
structures.

Income
Trusts have
more stable
earnings, so
their P/E
ratios are
more stable.
Other Multiples or Relative Value Ratios
Market-to-book (M/B) ratio
Price-to-sales (P/S) ratio
Price-to-cash-flow (P/CF) ratio
Market value to EBIT ratio
Market value to EBITDA ratio

Market-to-Book Ratio
Multiply justifiable M/B ratio times the firms book value per share to get an
estimate of intrinsic value
Advantages
Book values provide a relatively stable, intuitive measure of value relative to
market values
Eliminates problems associated with P/E multiples because book values are
rarely negative and are not volatile
Disdvantages
Book values may be sensitive to accounting standards
Book values may be uninformative for companies with few fixed assets
M/B ratio fell out of favour in the 1980s and 90s because high rates of
inflation distorted book values

Share per Value Book
Share per Price Market
/ = ratio B M
Price-to-Sales (P/S) Ratio
Multiply justifiable P/S ratio times the firms sales per share to
get an estimate of intrinsic value
Advantages
Sales are relatively insensitive to accounting decisions and are
never negative
Sales are not as volatile as earnings
Sales provide useful information about corporate decisions such
as product pricing
Disadvantages
Sales do not provide information about expenses and profit
margins which are key determinants of corporate performance.

Price-to-Cash-Flow (P/CF) Ratio
Cash Flow is estimated as Net Income + Depreciation and
Amortization + Deferred Taxes
Multiply justifiable P/CF ratio times the firms cash flow per
share to get an estimate of intrinsic value
Advantages
Reduces accounting concerns regarding earnings measurement

Market Value to EBIT or EBITDA
Multiply justifiable ratio times the firms forecast EBIT or
EBITDA per share to get an estimate of intrinsic value
Use Market Value of both Debt and Equity reflecting the fact
that EBIT or EBITDA represents income available to satisfy
the claims of both debt and equity holders
Advantages
Using EBIT and EBITDA instead of net income eliminates
volatility caused by EPS

(A Forecast Income Statement that could be used with EBIT and EBITDA ratios is
illustrated in Table 7 -2 on the following slide)

EBIT and EBITDA Ratios
Examples using Forecast Income Statement
Sales Volume 1 million units
Unit price $10 $10 million
Variable costs 5.0
Fixed cash costs 1.7
EBITDA 3.3
Depreciation 0.8
EBIT 2.5
Interest 0.5
EBT 2.0
Income Tax @ 50 percent 1.0
Net Income 1.0
Dividends 0.5
Book value of equity 5.0
Book value of debt 5.0
Table 7-2 Forecast Income Statement

3.3
MV
=
+
=
EBITDA
Equity Debt MV
ratio EBITDA

2.5
MV
=
+
=
EBIT
Equity Debt MV
ratio EBIT
Concluding Remarks
Use of comparative multiples is a popular approach
to valuing stock
Despite apparent simplicity of generating the ratios,
consideration of the accounting, volatility and other
issues affecting the usefulness of these approaches.
Summary and Conclusions
In this chapter you have learned:
Basic approaches to valuing preferred
and common shares including:
Dividend discount models
Relative valuation models
The importance of recognizing the
sensitivity of the valuation process to
assumptions regarding input variables
such as growth rates, discount rates
and general market conditions.
Concept Review Questions
Equity Valuation
Concept Review Question 1
Preferred Shares Versus Bonds
In what ways are preferred shares different from
bonds?

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