Valuation of Stocks

Chapter 5

5-3 Free Cash Flow Approach to Common Stock Valuation

This procedure could be used to value firms that

do not issue dividends

Free cash flow The net amount of cash flow

remaining after the firm has met all operating needs, including capital expenditures and working capital needs. Represents the cash amount that a firm could distribute to investors after meeting all its other obligations.
FCF = OCF FA WC

5-3 Free Cash Flow Approach to Common Stock Valuation

Weighted Average Cost of Capital The after-tax,

weighted average required return on all types of securities issued by a firm, where the weights equal the percentage of each type of financing in a firms capital structure.
This the aggregate rate that applies to all types of

investors.

5-4 Other Approaches to Common Stock Valuation

Liquidation value The amount of cash that remains if the

firms assets are sold and all liabilities paid. In most cases, the liquidation value is far below its market value. Book value the value of the firms equity as it appears in its balance sheet. It reflects the historical cost of its assets, adjusted for depreciation, net of its liabilities Comparable multiples A valuation method that calculates a valuation ratio or multiple for each firm in a sample of similar firms, and then uses the average or median pricing multiple for the sample firms to estimate a particular firms value.

5-5 Primary and Secondary Markets for Equity Securities

Investment banks financial institutions that assist firms in

raising long-term debt and equity financing in the worlds capital markets, advice corporations about major financial transactions, and are active in the business of selling and trading securities in secondary markets. Initial public offering a corporation offers its shares for sale to the public for the first time Seasoned equity offering a process used by an issuer to hire an investment banker with whom it directly negotiates the terms of the offer. Underwrite the investment banker purchases shares from a firm and resells them to investors.

5-5 Primary and Secondary Markets for Equity Securities

Secondary markets for equities where an investor can easily sell his or her holdings to someone else. Broker market a market in which the buyer and seller are brought together on a securities exchange to trade securities. (NYSE Euronext) Dealer market a market in which the buyer and seller are not brought together directly, but instead have their orders executed by market makers securities dealers who are market makers in the given security Market makers securities dealers that make markets by offering to buy or sell certain securities at stated prices Bid price the price at which a market maker offers to purchase a security; the price at which an investor can sell a security Ask price the price at which a market maker offers to sell a security; the price at which one can purchase a security.