Key Terms
Formula
Value = [CF1/(1+r)] + [CF2/(1+r)^2] + ... + TCF/(r-g)
What it tells you
How much investors pay for each $1 of net asset value.
Example
Par value = $1,000; dividend rate = 5%; required return = 10% D = $1,000 x 0.05 = $50 P = $50 / 0.10 = $500
Also called
Market-to-Book (M/B) ratio
Outstanding Also expressed as
Net Book Value / Shares Outstanding
Best used for
Mature companies with consistent, steadily growing dividends.
P/CF detail
Useful when a company shows a bottom-line loss due to depreciation or amortization but still has positive cash flows. No
Core concept
A stock's value = present value of all future dividends.
Where
D = annual dividend (par value x dividend rate); r = required return
Limitation
Cannot value companies that do not pay dividends (many major growth companies reinvest cash rather than pay dividends).
Then
P = [D0 x (1 + g)] / (r - g)
Process
1. Calculate dividends for each year of the high-growth phase
Used for
Mature companies with established dividend history that are expected to slow from rapid growth to stable growth.
Steps
1. Calculate dividends for each Stage 1 year; discount to PV 2.
Application steps
1. Discount each year's projected cash flow to present value 2.