1. Steak n Shake (Cash flow provided)
a/ Residual income model:
Year Net Required Residual PV factor PV
income income income
+1 (provided) (common Net income (of % cost fo Residual
. equity begin) x – required equity) income x PV
. cost of equity% income (find in factor
. factor table)
+10 (= 1/(1+r)^n)
Total XXX
Year Net Required Residual PV of PV PV
income income income continuing factor
value
+11 (provided) Common Net (Residual PV (PV of
equite income – income year factor continuing
begin x cost required +11) : (% cost of year value) x
equity % income equity - +10 (PV factor
%growth) year +10)
Total PV = (Total year +1 to year +10) + (PV year +11) + (common equity begin year
+1)
Mid-year adjustment = total PV x (1+ (%cost equity /2))
b/ PV of expected free cash flow model
Yr Cash flow Cash flow Cash flow (Inc.) Dec. Free Cash PV PV
from from for long In Cash Flow factor
operation investing term debt
s
+1 (provided) (provided (provided Net Cash flow (of % Free
. ) ) change in for cost cash
. cash dividends equity flow
. (provided (provided ) (find x PV
+1 ) ) in facto
0 table) r
TOTAL XXX
Yr CF CF CF (Inc.) Free CF PV of PV PV
Oper Invest. Debt Dec. In continuing Factor
. Cash value
+11 (pro.) (pro.) (pro. Net CF (Net (Pv (PV of
) change dividends change in factor continuing
in cash (pro.) cash year year factor) x
(pro.) +11) : (% +10) (PV factor
cost year +10)
, equity -
%growth)
Total PV = (total PV year +1 to year +10) + (PV year +11)
Mid year adjustment = total PV x (1+ (% cost equity /2))
c/ Dividend discount model:
The all-inclusive dividends to common shareholders are equal in amounts each year
to the free cash flows to the common shareholders in Part b. Thus, the valuation
using the dividend discount model is identical to the value computed in Part b.
above.
d/ Difference a/b/c
The valuations in Parts a.–c. are identical. If the valuations were not identical and
the amounts were small, the explanation would likely be rounding errors. If the
valuations differed more significantly, the valuation models probably were not
applied correctly.
e/ The market value of $XX is significantly less/more than the values determined in
Parts a.–c. above. Thus, it appears that the market significantly
underpriced/overpriced this firm.
2. Discussion questions:
a/ Characterize the primary differences among the valuation methods that are
derived from the dividend discount measurement of value. How do these methods
differ from the price multiple methods?
dividend discount model uses information about the expected dividends to be
paid by a firm to arrive at shareholder value, while the DCF method and the
models that analyse abnormal earnings on the other hand look at the firm’s cash
flows, and price multiple approaches make use of information regarding
earnings, book values of assets, or sales to arrive at a value
dividend discount model is not appropriate for firms that do not pay a dividend
while the other models can be used for all firms
note the relative simplicity of the price multiples method for analysts to use
versus the more detailed analysis of the other methods
differences in the treatment of the terminal value by the dividend discount and
other models
Literature on analysts’ choice of methods and on relative efficiency
b/ Valuation analysis involves a number of decisions and judgments that analysts
must make in deriving the fundamental (or intrinsic) value of a firm. Discuss the most
important analytical choices, including the choice of valuation model, in terms of their
potential impact on the outcome of the valuation.
Areas where qualitative judgement is required include financial forecasts, equity
risk premium estimation, cost of equity calculation, and terminal value
determination.
a/ Residual income model:
Year Net Required Residual PV factor PV
income income income
+1 (provided) (common Net income (of % cost fo Residual
. equity begin) x – required equity) income x PV
. cost of equity% income (find in factor
. factor table)
+10 (= 1/(1+r)^n)
Total XXX
Year Net Required Residual PV of PV PV
income income income continuing factor
value
+11 (provided) Common Net (Residual PV (PV of
equite income – income year factor continuing
begin x cost required +11) : (% cost of year value) x
equity % income equity - +10 (PV factor
%growth) year +10)
Total PV = (Total year +1 to year +10) + (PV year +11) + (common equity begin year
+1)
Mid-year adjustment = total PV x (1+ (%cost equity /2))
b/ PV of expected free cash flow model
Yr Cash flow Cash flow Cash flow (Inc.) Dec. Free Cash PV PV
from from for long In Cash Flow factor
operation investing term debt
s
+1 (provided) (provided (provided Net Cash flow (of % Free
. ) ) change in for cost cash
. cash dividends equity flow
. (provided (provided ) (find x PV
+1 ) ) in facto
0 table) r
TOTAL XXX
Yr CF CF CF (Inc.) Free CF PV of PV PV
Oper Invest. Debt Dec. In continuing Factor
. Cash value
+11 (pro.) (pro.) (pro. Net CF (Net (Pv (PV of
) change dividends change in factor continuing
in cash (pro.) cash year year factor) x
(pro.) +11) : (% +10) (PV factor
cost year +10)
, equity -
%growth)
Total PV = (total PV year +1 to year +10) + (PV year +11)
Mid year adjustment = total PV x (1+ (% cost equity /2))
c/ Dividend discount model:
The all-inclusive dividends to common shareholders are equal in amounts each year
to the free cash flows to the common shareholders in Part b. Thus, the valuation
using the dividend discount model is identical to the value computed in Part b.
above.
d/ Difference a/b/c
The valuations in Parts a.–c. are identical. If the valuations were not identical and
the amounts were small, the explanation would likely be rounding errors. If the
valuations differed more significantly, the valuation models probably were not
applied correctly.
e/ The market value of $XX is significantly less/more than the values determined in
Parts a.–c. above. Thus, it appears that the market significantly
underpriced/overpriced this firm.
2. Discussion questions:
a/ Characterize the primary differences among the valuation methods that are
derived from the dividend discount measurement of value. How do these methods
differ from the price multiple methods?
dividend discount model uses information about the expected dividends to be
paid by a firm to arrive at shareholder value, while the DCF method and the
models that analyse abnormal earnings on the other hand look at the firm’s cash
flows, and price multiple approaches make use of information regarding
earnings, book values of assets, or sales to arrive at a value
dividend discount model is not appropriate for firms that do not pay a dividend
while the other models can be used for all firms
note the relative simplicity of the price multiples method for analysts to use
versus the more detailed analysis of the other methods
differences in the treatment of the terminal value by the dividend discount and
other models
Literature on analysts’ choice of methods and on relative efficiency
b/ Valuation analysis involves a number of decisions and judgments that analysts
must make in deriving the fundamental (or intrinsic) value of a firm. Discuss the most
important analytical choices, including the choice of valuation model, in terms of their
potential impact on the outcome of the valuation.
Areas where qualitative judgement is required include financial forecasts, equity
risk premium estimation, cost of equity calculation, and terminal value
determination.
