FCFF and FCFE Valuation Approaches
Present Value of FCFF The free cash flow to the firm (FCFF) valuation approach estimates the firm’s value as the present value of future FCFF discounted at the weighted average cost of capital: $$\text{Firm Value}= ∑_{\text{t}=1}^∞\frac{\text{FCFF}_\text{t}}{(1+\text{WACC})^\text{t}}$$ Using the weighted…
Stock Value
If the current market price is greater than the intrinsic value estimated using the DDM, the stock is overvalued. If it is equal to the intrinsic value obtained from the DDM, the stock is fairly valued. If it is less…
Financial Determinants of Growth Rates
Sustainable Growth Rate Sustainable growth rate (SGR) is the growth rate of dividends (and earnings) that a company can maintain for a given return on equity (ROE), assuming that the capital structure remains unchanged, and no additional common stock is…
Spreadsheet (General) Modeling
Dividend discount models assume a stylized pattern of dividend growth. However, the dividend growth may follow a variety of patterns. Therefore, spreadsheet modeling is used to forecast any dividend pattern. In addition, spreadsheets allow analysts to build complicated models, perform…
The Required Rate of Return the Gordon Growth Model and the H-model
Given all the inputs to a dividend discount model (DDM) except the required return, the IRR can be calculated and used as a substitute for the required rate of return. This IRR can be interpreted as the expected return on…
Pricing using the Zero-Coupon Yield Curve and an Arbitrage-Free Binomial Lattice
Valuing a fixed-rate coupon bond with no embedded options using the arbitrage-free lattice and the spot curve leads to the same bond value. This holds because the binomial interest rate tree is arbitrage-free. However, the spot curve will not work…
Structure and Features of Credit Default Swaps (CDS)
A credit derivative is an agreement between two parties, a credit protection buyer and a credit protection seller. The protection seller provides protection to the buyer against a particular credit loss. Among the various types of credit derivatives, credit…
Credit Analysis for Securitized Debt
Securitized debt allows the issuers to finance a specific set of assets such as mortgages and auto loans rather than the entire balance sheet, unlike other risky bonds. Investors of securitized debt benefit from greater diversification, more stable and predictable…
The Value of Common Shares using Multiperiod Models
Two-Stage Dividend Discount Model There are two approaches to the two-stage dividend discount model: i. The General Two-Stage Model Under this model, a company’s growth is divided into two sections—one where it experiences high growth and the second where its…
Term Structure of Credit Spreads
A credit curve is a graphical representation of the spread over benchmark security for an issuer of a credit risky bond across maturities. The following shows the term structure of credit spreads: The higher the time to maturity, the greater…
