Description
Valuation The Art and Science of Corporate Investment Decisions Edition 5
by Sheridan Titman EBOOK PDF Instant Download
Table of Contents
Valuation
Valuation The Art and Science of Corporate Investment Decisions
About the Authors
Brief Contents
Detailed Contents
Preface
Project and Enterprise Valuation
What’s New in the Third Edition?
A Holistic Approach to Valuation
Pedagogical Features
Supplements
Structure of the Book
Chapter 1 Introduction to Valuation
Chapter Overview
1.1 Introduction
1.2 The Nature of Major Investment Decisions
1.3 Valuing Projects and Businesses
Project Valuation—Investing in the Caspian Sea Oil Fields
Issues to Consider When Valuing an Investment
Issue #1: Does the “Story” Make Sense?
Issue #2: What Are the Risks Entailed in the Investment, and How Can They Be Assessed and Dealt with in the Analysis?
Issue #3: How Can the Investment Be Financed?
Issue #4: How Does the Investment Affect Near-Term Earnings?
Issue #5: Does the Investment Have Inherent Flexibilities That Allow the Firm to Respond to Changing Circumstances?
Can the investment be staged?
Does the investment offer the opportunity for follow-on investments?
Does the investment provide production or marketing synergies with existing products?
Enterprise Valuation—Mergers and Acquisitions
1.4 Dealing with Complexity—Process and Discipline
The Investment Evaluation Process
Phase I: Investment (Idea) Origination and Analysis
Phase II: Managerial Review and Recommendation
Phase III: Managerial Decision and Approval
1.5 Case Study—CP3 Pharmaceuticals Laboratories Inc.
Example: Investing in a New Materials-Handling System
Addressing the Possibility of Decision Bias
The Role of the Strategic Planning Committee As the Skeptical Boss
1.6 Summing Up and Looking Forward
Final Comments—The Investment Decision-Making Process
Looking Forward—The Structure of the Rest of the Text
Part I Project Analysis Using Discounted Cash Flow
Chapter 2 Forecasting and Valuing Cash Flows
Chapter Overview
2.1 Discounted Cash Flows and Valuation
Example—Car Wash
The Three-Step DCF Process
2.2 Defining Investment Cash Flows
Only Incremental Cash Flows Are Relevant
Expected Versus Conservative and Optimistic Cash Flow Estimates
Equity Versus Project Free Cash Flow
Calculating Project Free Cash Flow (FCF)
2.3 Comprehensive Example—Forecasting Project Free Cash Flows
Lecion’s Strategic Assessment of the LCD Investment Opportunity
Estimating the Investment’s Project Free Cash Flow
Forecasting Incremental Revenues
Estimating Total Annual Expenses
2.4 Valuing Investment Cash Flows
Example—Valuing Lecion’s Project Cash Flows
Using NPV and IRR to Evaluate the Investment
Mutually Exclusive Projects
2.5 Calculating Project Free Cash Flows Using Pro Forma Accounting Statements
Example—Extracting FCF from Pro Forma Financial Statements
Constructing Pro Forma Financial Statements
Computing FCFs Using Pro Forma Financial Statements
Computing Project NPV
Key Learning Points—Pro Forma Financial Statements and FCF
2.6 Summary
Exercises
Problems
Chapter 3 Project Risk Analysis
Chapter Overview
3.1 Introduction
3.2 Uncertainty and Investment Analysis
The Investment Process with Risky Cash Flows
Example—The Earthilizer Proposal
Estimating Earthilizer’s Project Free Cash Flows (FCFs)
Valuing Earthilizer’s Project FCFs
The Decision to Invest (or Not)—NPV and IRR
3.3 Sensitivity Analysis—Learning More About the Project
Scenario Analysis
Breakeven Sensitivity Analysis
Simulation Analysis
Using Scenario Analysis as a Prelude to Building a Simulation Model
Preparing and Running a Simulation
Simulating Project Revenues
Forecasting Project Cash Flows
Liquidating the Investment and the Terminal Value
Simulation Software
Interpreting Simulation Results
Analyzing the Distributions of NPV and IRR
Using the Tornado Diagram to Perform Sensitivity Analysis
Summarizing the Simulation Results
Reflections on the Use of Simulation
Extensions of the Earthilizer Model
Using Simulations to Estimate an Investment’s Contribution to Firm and Market Risk
3.4 Decision Trees—Valuing Project Flexibility
Example—Decision Tree Analysis of the Abandonment Option
Evaluating the Revised Earthilizer Project Without the Abandonment Option
The Value of the Abandonment Option
Using Option Pricing Theory to Evaluate the Abandonment Option
3.5 Summary
Exercises
Problems
What Is Simulation?
Why Build Simulation Models?
What Is Crystal Ball Software?
How Do I Build a Simulation Model Using Crystal Ball?
Part II Cost of Capital
Chapter 4 Estimating a Firm’s Cost of Capital
Chapter Overview
4.1 Introduction
4.2 Value, Cash Flows, and Discount Rates
Defining a Firm’s WACC
Use Market Value Weights
Use Market-Based Opportunity Costs
Use Forward-Looking Weights and Opportunity Costs
Discounted Cash Flow, Firm Value, and WACC
Illustration—Using Discounted Cash Flow Analysis to Value an Acquisition
Equity Valuation
Equity Free Cash Flow
Equity Valuation Example—OfficeMart Inc.
4.3 Estimating WACC
Evaluate the Firm’s Capital Structure Weights—Step 1
Calculate the Cost of Debt—Step 2
Promised or Contractual Yields to Maturity on Corporate Bonds
Promised Versus Expected Rates of Return
Estimating the Cost of Convertible Corporate Bonds
Calculate the Cost of Preferred Equity—Step 2 (continued)
Calculate the Cost of Common Equity—Step 2 (continued)
Method 1—Asset Pricing Models
The Traditional CAPM
Selecting the Risk-Free Rate of Interest
Identifying the Risk-Free Rate
Choosing a Maturity
Estimating the Beta
Case 1: Constant Level of Debt
Case 2: Constant Debt to Value Ratio
Summary of Equity Betas and Financial Leverage
Estimating the Market Risk Premium
Common Valuation Mistakes: Failure to Risk-Adjust Comparison Firms
Historical Estimates
CAPM with a Size Premium
Factor Models
Limitations of Cost of Equity Estimates Based on Historical Returns
Historical Security Returns Are Highly Variable
Market Conditions Are Changing
Historical Returns Exhibit Survivor Bias
Method 2—Discounted Cash Flow or Imputed Rate of Return Approaches
Single-Stage DCF Growth Model
Aggregating the Forward-Looking Equity Risk Premia
Three-Stage Growth Model
Calculating the WACC (Putting It All Together)—Step 3
Evaluating Champion’s Capital Structure
Estimating Champion’s Costs of Debt and Equity Capital
Calculating Champion’s WACC
Taking a Stand on the Issues—Estimating the Firm’s Cost of Capital
4.4 Summary
Exercises
Problems
Estimating the Expected Cost of Below-Investment-Grade Debt Financing
Default Rates, Recovery Rates, and Yields on Corporate Debt
Estimating the Expected Yield to Maturity for a Long-Term Bond
Estimating the Cost of Hybrid Sources of Financing—Convertible Bonds
Off-Balance-Sheet Financing and WACC
Special-Purpose Entities
Chapter 5 Estimating Required Rates of Return for Projects
Chapter Overview
5.1 Introduction
5.2 Pros and Cons of Multiple Risk-Adjusted Costs of Capital
The Rationale for Using Multiple Discount Rates
Convincing Your Skeptical Boss—Low-Risk Projects Can Be Good Investments
The Benefits of Using a Single Discount Rate
Influence Costs
Weighing the Costs and Benefits of Multiple Versus Single Discount Rates
5.3 Choosing a Project Discount Rate
Method 1: Divisional WACC (Industry-Based Divisional Costs of Capital)
Divisional WACC—Estimation Issues and Limitations
Method 2: Project-Specific WACCs
Example: Determining Project-Specific WACC for Project-Financed Projects
Estimating Project Equity Value Directly—the Flow-Through-to-Equity Model
Estimating the Cost of Equity and Project Free Cash Flows (FCFs)
Estimating the Value of the Equity and the Cost of Equity Capital Using Iteration
Calculating Project Value and Project Finance WACC
Project-Specific WACC with Corporate Financing
Project Debt Capacity—How Much Debt Will the Project Support?
What Are the Appropriate Costs of Debt and Equity for an Individual Project?
Summary for Adjusting Project WACC Using Project Debt Capacity
5.4 Hurdle Rates and the Cost of Capital
Mutually Exclusive Projects
High Hurdle Rates May Provide Better Incentives for Project Sponsors
Accounting for Optimistic Projections and Selection Bias
5.5 Summary
Exercises
Problems
Part III Financial Statements and Valuation
Chapter 6 Forecasting Financial Performance
Chapter Overview
6.1 Introduction
6.2 Understanding Financial Statements and Cash Flow
The Income Statement
Cash Versus Accrual Accounting—Net Income Is Not the Same As Cash Flow
Operating Versus Nonoperating Income
Common Size Income Statement
The Balance Sheet
Measurement—Where Do the Numbers Come From?
Nonoperating Assets and Investments
The Common Size Balance Sheet
Statement of Cash Flow
Free Cash Flow Computations
Firm (Project) Free Cash Flow
Direct Method for Calculating Firm Free Cash Flow
Indirect Method for Calculating Firm Free Cash Flow
Other Income and Firm Free Cash Flow
Equity Free Cash Flow
Reconciling the Cash Flow Statement with Firm FCF
Free Cash Flow and Nonoperating Income
6.3 Forecasting Future Financial Performance
Step 1: Perform an Analysis of Historical Financial Statements
Performing a Financial Statement Analysis
Step 2: Construct Pro Forma Financial Statements for the Planning Period
The Forecast Horizon
Developing a Revenue Forecast
Forecast Methods Used to Construct Pro Forma Statements
Pro Forma Income Statements
Pro Forma Balance Sheets
When the Percentage of Sales Method Should Not Be Used
Step 3: Convert Pro Forma Financial Statements to Cash Flow Forecasts
Step 4: Estimate the Terminal Value of Firm Free Cash Flows
6.4 Looking Ahead—The Mechanics of Calculating Enterprise Value
Planning Period and Terminal Value
6.5 Summary
Exercises
Problems
Chapter 7 Earnings Dilution, Incentive Compensation, and Project Selection
Chapter Overview
7.1 Introduction
7.2 Are Reported Earnings Important?
Why Managers Care About Earnings
7.3 Project Analysis—Earnings per Share and Project Selection
Example 1—Bad Project with Good Earnings Prospects: The Equity-Cost Problem
How Can Projects with Negative NPVs Increase EPS?
Issuing New Equity: EPS Accretion/Dilution and the Price-to-Earnings Ratio
Generalizing the Earnings Accretion/Dilution Analysis
Debt Financing and Earnings Dilution
Example 2—Good Project with Back-Loaded Earnings Prospects
Earnings Effects—Accretion Versus Dilution
7.4 Economic Profit and the Disconnect Between EPS and NPV
Economic Profit (EVA®)
Using Economic Profit to Evaluate the Equity-Cost Problem
Using Economic Profit to Evaluate the Back- and Front-Loaded Earnings Problems
Back-Loaded Earnings
Front-Loaded Earnings
Summing Up
7.5 Practical Solutions—Using Economic Profit Effectively
Modifying the Calculation of Economic Profit
Modifying the Method Used to Pay Bonuses Based on Economic Profit
7.6 Summary
Exercises
Problems
Part IV Enterprise Valuation
Chapter 8 Relative Valuation Using Market Comparables
Chapter Overview
8.1 Introduction
8.2 Valuation Using Comparables
Valuing Residential Real Estate Using Comparables
Valuing Commercial Real Estate
Valuation Ratios (Multiples) and DCF Valuation
Office-Building Example
Valuation When the Buildings Are Not Identical
Operating Leverage and Investment Risk
Investigating the Determinants of Cash Flows
Key Learning Points
8.3 Enterprise Valuation Using EBITDA Multiples
Enterprise Value Versus Firm Value
The Airgas EBITDA Multiple
Example: Valuing a Privately Held Firm
EBITDA and Firm Free Cash Flow
Why Use EBITDA Multiples Rather than Cash Flow Multiples?
The Effects of Risk and Growth Potential on EBITDA Multiples
Normalizing EBITDA
Adjusting the Valuation Ratio for Liquidity Discounts and Control Premiums
8.4 Equity Valuation Using the Price-to-Earnings Multiple
Example—Valuing ExxonMobil’s Chemical Division Using the P/E Method
P/E Multiples for Stable-Growth Firms
P/E Multiple for a High-Growth Firm
8.5 Pricing an Initial Public Offering
8.6 Other Practical Considerations
Selecting Comparable Firms
Choosing the Valuation Ratio
Maintaining Consistency When Selecting a Valuation Ratio
Dealing with Unreliable Financial Information
Valuation Ratios Versus DCF Analysis
8.7 Summary
Exercises
Problems
Valuation Assignment
Chapter 9 Enterprise Valuation
Chapter Overview
9.1 Introduction
9.2 Using a Two-Step Approach to Estimate Enterprise Value
Example: Immersion Chemical Corporation Acquires Genetic Research Corporation
Valuing GRC Using DCF Analysis
Valuing GRC Under the Growth Strategy
Sensitivity Analysis
Sensitivity Analysis: Cost of Capital
Sensitivity Analysis: Revenue Growth Rate
Sensitivity Analysis: Terminal-Value EBITDA Multiple
Scenario Analysis
9.3 Using the APV Model to Estimate Enterprise Value
Introducing the APV Approach
Using the APV Approach to Value GRC Under the Growth Strategy
Step 1: Estimate the Value of the Planning Period Cash Flows
Step 2: Estimate GRC’s Terminal Value
Step 3: Summing the Values of the Planning Period and Terminal Period
Using an EBITDA Multiple to Calculate the Terminal Value
Comparing the WACC and APV Estimates of GRC’s Enterprise Value
A Brief Summary of the WACC and APV Valuation Approaches
Estimating the Value of Subsidized Debt Financing
9.4 Summary
Exercises
Problems
Chapter 10 Valuation in a Private Equity Setting1
Chapter Overview
10.1 Introduction
10.2 Overview of the Market for Private Equity
Market for Private Equity—Financial Intermediaries
Investors—The Suppliers of Private Equity Finance
Investments—The Demand for Private Equity Finance
10.3 Valuing Investments in Startups and Deal Structuring
The Cost of Capital for Venture Capital Financing
How do you think about rates of return you target for private equity investing?
How much of your endowment portfolio do you allocate to private equity?
Valuing a VC Investment and Structuring the Deal
Investor Expectations
Valuing Bear-Builders.com’s Equity
Estimating Enterprise Value at the End of the Planned Investment Period
Computing Ownership Interests—Defining the Deal Structure
Summing Up the Venture Capital Method
Pre- and Post-Money Value of the Firm’s Equity
Refining the Deal Structure
Using Staged-Financing Commitments
Using Debt or Preferred Stock
10.4 Valuing Leveraged Buyout Investments
Alternative LBO Acquisition Strategies—Bust-Ups and Build-Ups
Example—Build-Up LBOs
Estimating Equity Returns for the Platform Company
Analyzing the Returns from the Add-On Investment
A Limitation of the Private Equity (LBO) Valuation Approach
Valuing PMG Inc. Using the Hybrid Adjusted Present Value Approach
Private Equity Value Drivers
10.5 Summary
Exercises
Problems
Terminology
Part V Futures, Options, and the Valuation of Real Investments
Chapter 11 Using Futures and Options to Value Real Investments
Chapter Overview
11.1 Introduction
11.2 The Certainty-Equivalence Method
Forward Prices as Certainty-Equivalent Cash Flows
11.3 Using Forward Prices to Value Investment Projects
Example: Pricing Against the Forward Price Curve
Convincing Your Skeptical Boss
11.4 Using Option Prices to Value Investment Opportunities
Option Value and Nonrecourse Financing
Valuing the Investment Using Forward Prices
Analyzing Equity Value with the Default Option—Managing the Project
Convincing Your Skeptical Boss
11.5 Caveats and Limitations—Tracking Errors
How Liquid Are Futures, Forward, and Option Markets?
Uncertain Quantities and Operating Costs
Basis Risk
Differences in Product Quality
Differences in Geographic Locations
Differences in Contract Terms
The Relation Between Tracking Error and Imperfect Comps
11.6 Using an Option Pricing Model to Value Investments
Example—Valuing the Cotton Valley Investment Using the Binomial Option Pricing Model
How Does Volatility Affect Option Values?
Calibrating Option Pricing Models
11.7 Summary
Exercises
Problems
What Is an Option?
How Can We Characterize the Payoffs to Option Contracts?
Defining Call Option Payoffs
Defining Put Option Payoffs
Risk and the Valuation of Options
Valuing Call Options Using the Black-Scholes Model
Summing Up
Chapter 12 Managerial Flexibility and Project Valuation: Real Options
Chapter Overview
12.1 Introduction
12.2 Types of Real Options
Real Options to Consider Before an Investment Launch
Real Options to Consider After an Investment Launch
12.3 Why Real Option Valuation Is Difficult
12.4 Valuing Investments That Contain Embedded Real Options
The Option to Invest: Staged Investments
Valuing an Oil Lease
Traditional (Static) DCF Analysis of the Lease
Certainty-Equivalent Analysis—Using the Forward Price to Value the Lease
Dynamic Analysis—Valuing the Lease As an Option to Produce Oil
Valuing the Option to Delay or Wait
Hedging the Price Risk of Delaying the Decision to Invest
More Complicated Options and the Incentive to Wait
Do Firms Delay Optimally?
Option to Abandon
Stripper Well Example
12.5 Analyzing Real Options As American-Style Options
Evaluating National Petroleum’s Option to Drill
Hedging Oil Price Risk
Considering the Option to Delay
Valuing American Options Using a Binomial Lattice
Solving for the Value of the Undeveloped Oil Field
Constructing the Binomial Lattice for the Developed Oil Field
Real Option Valuation Formula
Real Estate Development Option
How Do Changes in Model Parameters Affect Real Option Values?
Extensions of the Model
Applying the Model to a Chemical Plant
Limitations of the Model
12.6 Using Simulation to Value Switching Options
Option to Switch Inputs
Static NPV Analysis of the Plant Choices
Dynamic Analysis—Valuing the Option to Switch Fuel Sources
Modeling Future Oil and Gas Prices
Using Simulation to Value the Flexibility Option
Trying to Fit the Problem into the Black-Scholes Model
Using the Wrong Volatility
Assuming That the Exercise Price of the Real Option Is Fixed
Overestimating the Value of Flexibility
Double-Counting Risk
12.7 Summary
Exercises
Problems
Multiple Time Steps per Year
Building the Binomial Lattice for the National Petroleum Oil Field Investment
Chapter 13 Strategic Options: Evaluating Strategic Opportunities
Chapter Overview
13.1 Introduction
13.2 Where Do Positive NPV Investments Come From?
13.3 Valuing a Strategy with Staged Investments
Description of Vespar’s New Coal Technology
Stand-Alone Project Analysis of the Initial Plant
Analyzing Projects As Part of a Strategy
Details of the Plan
A Naïve, Static Analysis of the Value of Vespar’s Strategy
An Option Pricing Approach for Evaluating Vespar’s Strategy
Recapping the Analysis of the Vespar Strategy
Using DCF Analysis to Estimate the Value of Vespar’s Strategy
The Anatomy of Vespar’s Power Plant Strategy
Sensitivity Analysis of Vespar’s Power Plant Strategy
Sensitivity Analysis of the Strategy One Variable at a Time
Simulation Analysis of the Strategy
13.4 Strategic Value When the Future Is Not Well Defined
Which Investments Generate Strategic Options?
How Does Corporate Structure Affect Strategic Option Value?
Management Incentives, Psychology, and the Exercise of Strategic Options
13.5 Summary
Exercises
Problems
Epilogue
Index
