based on the amount of money
that the company or the assets
will generate over the period of
time.
theorizes that the best estimate of
value is based on the returns that
an asset or business can generate
in the future
DIVIDEND IRRELEVANCE THEORY
BIRD-IN-THE HAND THEORY
Franco Modigliani Merton H. Miller
DIVIDEND IRRELEVANCE THEORY
DIVIDEND IRRELEVANCE THEORY
stock prices are not affected by
dividends or the returns on the stock but
more on the ability and sustainability of
the asset or company.
Myron Gordon John Lintner
DIVIDEND RELEVANCE THEORY
DIVIDEND RELEVANCE THEORY
Simply known as bird-in-the hand theory,
believes that dividend or capital gains has
an impact on the price of the stock.
EARNING ACCRETION
additional value inputted in the calculation
that would account for the increase in
value of the firm due to other quantifiable
attributes like potential growth, increase in
prices, and even operating efficiencies.
EARNING DILUTION
Reduce value if there were
future circumstances that will
affect the firm negatively
EQUITY CONTROL PREMIUM
an amount that is added to the value of the
firm in order to gain control of it.
PRECEDENT TRANSACTIONS
Previous deals or experiences that can be
similar with the investment being evaluated
Cost of capital
a key driver in the income-based approach.
Computations:
✓ Weighted Average Cost of Capital
(WACoC)
✓ Capital Asset Pricing mode (CAPM)
formula can be used in determining the
minimum required return
WACoC= (ke x We) + (kd x Wd)
Ke = Cost of equity
We= weight of equity financing
Kd= cost of debt after tax
Wd= weight of the debt financing
may also include other sources of financing
The cost of equity may also be derived
using Capital Asset Pricing Model or
CAPM.
Ke = Rf + ꞵ(Rm - Rf)
Rf = Risk free rate
ꞵ = beta
Rm = market rate
Ke = Cost of equity
Ke = Rf + ꞵ (Rm - Rf)
Rf = 5%
ꞵ = 1.5
Rm = 11.91%
Ke = ?
Ke = 5% + 1.5 (11.91% - 5%)
= 5% + 1.5 (6.91%)
= 5% + 10.365%
= 15.365%
If there will be portion raised through
debt. Cost of debt can be computed by
adding debt premium over the risk-
free rate
Kd = Rf + DM
Rf = Risk free rate
DM = debt margin
Kd = Cost of debt
Kd = Rf + DM
Rf = 5%
DM = 6% Kd = 5% + 6%
Kd = ? = 11%
ECONOMIC VALUE ADDED
The most conventional way to determine the
value of the asset.
In economics and financial management, is a
convenient metric in evaluating investment as it
quickly measures the ability of the firm to
support its cost of capital using its earnings.
WACoC= (ke x We) + (kd x Wd)
Ke = 15.365%
We = 30%
Kd = 11%
Wd = 70% WACoC= (15.365% x 30%) + (11% x 70%)
WACoC= ? = 4.61% + 7.7%
WACoC = 12.31%
WACoC= (ke x We) + (kd x Wd)
Kd = 11% x ( 1-30%)
= 11% x 70%
Kd = 7.7%
WACoC= (15.365% x 30%) + (7.7% x 70%)
= 4.6095% + 5.39%
WACoC = 9.9995% or 10%
Elements that must be considered in using
EVA:
ECONOMIC VALUE ADDED
Earnings
Less: Cost of Capital
Economic Value Added
Investment value
X: Rate of Cost Capital
Cost of Capital
Earnings = 350 Million
Cost of Capital =?
EVA =?
Investment value = 1.5 Billion
Rate of Cost Capital = 10%
Cost of capital = 1.5 Billion x 10%
= 150 Million
EVA = 350 Million – 150 Million
= Php 200 Million
Capitalization of Earnings Method
used to value a business based on the
future estimated benefits, normally
using some measure of earnings or cash
flows to be generated by the company.
Capitalization of Earnings Method provides
for the relationship of the:
1. Estimated earnings of the company
2. Expected yield or the required rate of
return
3. Estimated equity value
Capitalization of Earnings Method
Equity Value = Future Earnings
Required Return
Equity Value =?
Future earnings = Php 450,000
Required return = 12%
EVA = 450,000/12%
= Php 3.75 Million
Equity Value =?
Future earnings = Php 450,000
Required return = 12%
Ave. Future Earnings = (450T + 500T + 650T + 700T + 750T) / 5yrs.
= 3,050,000/5yrs.
= 610,000
Equity Value = 610,000/12%
= Php 5,083,333
Capitalization of Earnings Method
Equity Value = Capitalized assets + Idle Assets
Equity Value =?
Capitalized assets = 5,033,333
Idle Assets = 1,350,000
Equity Value = 5,033,333 + 1,350,000
= Php 6,433,333
Capitalization of Earnings Limitations:
1. does not fully account for the future
earnings or cash flows
2. inability to incorporate contingencies
3. assumptions used to determine the
cash flows may not hold true
