Chapter 1 Introduction to Valuation 1
A Philosophical Basis for Valuation 1
Generalities about Valuation 2
The Role of Valuation 6
Conclusion 9
Questions and Short Problems 9
Chapter 2 Approaches to Valuation 11
Discounted Cash Flow Valuation 11
Relative Valuation 19
Contingent Claim Valuation 23
Conclusion 25
Questions and Short Problems 25
Chapter 3 Understanding Financial Statements 27
The Basic Accounting Statements 27
Asset Measurement and Valuation 29
Measuring Financing Mix 36
Measuring Earnings and Profitability 42
Measuring Risk 47
Other Issues in Analyzing Financial Statements 53
Conclusion 55
Questions and Short Problems 55
Chapter 4 The Basics of Risk 58
What is Risk? 58
Equity Risk and Expected Return 59
Alternative Models for Equity Risk 71
A Comparative Analysis of Equity Risk Models 76
Models of Default Risk 77
Conclusion 81
Questions and Short Problems 82
Chapter 5 Option Pricing Theory and Models 87
Basics of Option Pricing 87
Determinants of Option Value 89
Option Pricing Models 90
Extensions of Option Pricing 107
Conclusion 109
Questions and Short Problems 109
Chapter 6 Market Efficiency—Definition, Tests, and Evidence 111
Market Efficiency and Investment Valuation 111
What Is an Efficient Market? 112
Implications of Market Efficiency 112
Necessary Conditions for Market Efficiency 114
Propositions about Market Efficiency 114
Testing Market Efficiency 116
Cardinal Sins in Testing Market Efficiency 120
Some Lesser Sins That Can Be a Problem 121
Evidence on Market Efficiency 122
Time Series Properties of Price Changes 122
Market Reaction to Information Events 130
Market Anomalies 134
Evidence on Insiders and Investment Professionals 142
Conclusion 149
Questions and Short Problems 150
Chapter 7 Riskless Rates and Risk Premiums 154
The Risk-Free Rate 154
Equity Risk Premium 159
Default Spreads on Bonds 177
Conclusion 180
Questions and Short Problems 180
Chapter 8 Estimating Risk Parameters and Costs of Financing 182
The Cost of Equity and Capital 182
Cost of Equity 183
From Cost of Equity to Cost of Capital 210
Best Practices at Firms 221
Conclusion 222
Questions and Short Problems 223
Chapter 9 Measuring Earnings 229
Accounting versus Financial Balance Sheets 229
Adjusting Earnings 230
Conclusion 247
Questions and Short Problems 249
Chapter 10 From Earnings to Cash Flows 250
The Tax Effect 250
Reinvestment Needs 258
Conclusion 268
Questions and Short Problems 269
Chapter 11 Estimating Growth 271
The Importance of Growth 272
Historical Growth 272
Analyst Estimates of Growth 282
Fundamental Determinants of Growth 285
Qualitative Aspects of Growth 301
Conclusion 302
Questions and Short Problems 302
Chapter 12 Closure in Valuation: Estimating Terminal Value 304
Closure in Valuation 304
The Survival Issue 318
Closing Thoughts on Terminal Value 320
Conclusion 321
Questions and Short Problems 321
Chapter 13 Dividend Discount Models 323
The General Model 323
Versions of the Model 324
Issues in Using the Dividend Discount Model 344
Tests of the Dividend Discount Model 345
Conclusion 348
Questions and Short Problems 349
Chapter 14 Free Cash Flow to Equity Discount Models 351
Measuring What Firms Can Return to Their Stockholders 351
FCFE Valuation Models 357
FCFE Valuation versus Dividend Discount Model Valuation 372
Conclusion 376
Questions and Short Problems 376
Chapter 15 Firm Valuation: Cost of Capital and Adjusted Present Value Approaches 380
Free Cash flow to the Firm 380
Firm Valuation: The Cost of Capital Approach 383
Firm Valuation: The Adjusted Present Value Approach 398
Effect of Leverage on Firm Value 402
Adjusted Present Value and Financial Leverage 415
Conclusion 419
Questions and Short Problems 419
Chapter 16 Estimating Equity Value per Share 423
Value of Nonoperating Assets 423
Firm Value and Equity Value 440
Management and Employee Options 442
Value per Share When Voting Rights Vary 448
Conclusion 450
Questions and Short Problems 451
Chapter 17 Fundamental Principles of Relative Valuation 453
Use of Relative Valuation 453
Standardized Values and Multiples 454
Four Basic Steps to Using Multiples 456
Reconciling Relative and Discounted Cash Flow Valuations 466
Conclusion 467
Questions and Short Problems 467
Chapter 18 Earnings Multiples 468
Price-Earnings Ratio 468
The PEG Ratio 487
Other Variants on the PE Ratio 497
Enterprise Value to EBITDA Multiple 500
Conclusion 508
Questions and Short Problems 508
Chapter 19 Book Value Multiples 511
Price-to-Book Equity 511
Applications of Price–Book Value Ratios 521
Use in Investment Strategies 530
Value-to-Book Ratios 532
Tobin’s Q: Market Value/Replacement Cost 537
Conclusion 539
Questions and Short Problems 539
Chapter 20 Revenue Multiples and Sector-Specific Multiples 542
Revenue Multiples 542
Sector-Specific Multiples 571
Conclusion 577
Questions and Short Problems 577
Chapter 21 Valuing Financial Service Firms 581
Categories of Financial Service Firms 581
What is Unique about Financial Service Firms? 582
General Framework for Valuation 583
Discounted Cash Flow Valuation 584
Asset-Based Valuation 599
Relative Valuation 599
Issues in Valuing Financial Service Firms 605
Conclusion 607
Questions and Short Problems 608
Chapter 22 Valuing Firms with Negative or Abnormal Earnings 611
Negative Earnings: Consequences and Causes 611
Valuing Negative Earnings Firms 615
Conclusion 639
Questions and Short Problems 639
Chapter 23 Valuing Young or Start-Up Firms 643
Information Constraints 643
New Paradigms or Old Principles:
A Life Cycle Perspective 644
Venture Capital Valuation 646
General Framework for Analysis 648
Value Drivers 659
Estimation Noise 661
Implications for Investors 662
Implications for Managers 663
The Expectations Game 663
Conclusion 665
Questions and Short Problems 666
Chapter 24 Valuing Private Firms 667
What Makes Private Firms Different? 667
Estimating Valuation Inputs at Private Firms 668
Valuation Motives and Value Estimates 688
Valuing Venture Capital and Private Equity Stakes 693
Relative Valuation of Private Businesses 695
Conclusion 699
Questions and Short Problems 699
Chapter 25 Aquisitions and Takeovers 702
Background on Acquisitions 702
Empirical Evidence on the Value Effects of Takeovers 705
Steps in an Acquisition 705
Takeover Valuation: Biases and Common Errors 724
Structuring the Acquisition 725
Analyzing Management and Leveraged Buyouts 730
Conclusion 734
Questions and Short Problems 735
Chapter 26 Valuing Real Estate 739
Real versus Financial Assets 739
Discounted Cash Flow Valuation 740
Comparable/Relative Valuation 759
Valuing Real Estate Businesses 761
Conclusion 763
Questions and Short Problems 763
Chapter 27 Valuing Other Assets 766
Cash-Flow-Producing Assets 766
Non-Cash-Flow-Producing Assets 775
Assets with Option Characteristics 777
Conclusion 778
Questions and Short Problems 779
Chapter 28 The Option to Delay and Valuation Implications 781
The Option to Delay a Project 781
Valuing a Patent 789
Natural Resource Options 796
Other Applications 802
Conclusion 802
Questions and Short Problems 803
Chapter 29 The Options to Expand and to Abandon: Valuation Implications 805
The Option to Expand 805
When Are Expansion Options Valuable? 812
Valuing a Firm with the Option to Expand 815
Value of Financial Flexibility 817
The Option to Abandon 820
Reconciling Net Present Value and Real Option Valuations 823
Conclusion 823
Questions and Short Problems 824
Chapter 30 Valuing Equity in Distressed Firms 826
Equity in Highly Levered Distressed Firms 826
Implications of Viewing Equity as an Option 828
Estimating the Value of Equity as an Option 831
Consequences for Decision Making 836
Conclusion 839
Questions and Short Problems 839
Chapter 31 Value Enhancement: A Discounted Cash Flow Valuation Framework 841
Value-Creating and Value-Neutral Actions 841
Ways of Increasing Value 842
Value Enhancement Chain 859
Closing Thoughts on Value Enhancement 864
Conclusion 865
Questions and Short Problems 865
Chapter 32 Value Enhancement: Economic Value Added, Cash Flow Return on Investment, and Other Tools 869
Economic Value Added 870
Cash Flow Return on Investment 884
A Postscript on Value Enhancement 890
Conclusion 891
Questions and Short Problems 891
Chapter 33 Probabilistic Approaches in Valuation: Scenario Analysis, Decision Trees, and Simulations 894
Scenario Analysis 894
Decision Trees 899
Simulations 908
An Overall Assessment of Probabilistic Risk-Assessment Approaches 919
Conclusion 921
Questions and Short Problems 921
Chapter 34 Overview and Conclusion 925
Choices in Valuation Models 925
Which Approach Should You Use? 926
Choosing the Right Discounted Cash Flow Model 929
Choosing the Right Relative Valuation Model 933
When Should You Use the Option Pricing Models? 937
Conclusion 938
References 939
Index 954
