CH.

8
PROSPECTIVE ANALYSIS:
VALUATION IMPLEMENTATION
 Computing a Discount Rate
 Weighted average cost of capital (WACC):
weighting the costs of debt and equity capital
according to their respective market values
 Market value for debt: use book value
 Market value of equity: “insert” target ratios of debt to
capital and equity to capital.
 Estimating the cost of debt: interest rate on the debt
(net-of-tax)
 Estimating the cost of equity: use Capital Asset
Pricing Model (CAPM)
 Terminal Values

 Remain constant
 Grow at the assumed sales growth rate
 Using multiple
 Selecting terminal years: usually 5-10 year
forecast horizon
 Dealing with Accounting Distortions

 Self correcting nature of double-entry

bookkeeping, estimated values will not be
affected by accounting choices, as long as the
analysts recognizes the accounting distortions
 Dealing with Negative Book Values

 Makes it difficult to use the accounting-based

approach to value a firm’s equity
 Approach to handle this problem:
 Value the firm’s assets rather than equity
 “Undo” accountants’ conservatism by capitalizing
the investment expenditures written off
 Start from the observed stock and work backwards