Equity Valuation and Analysis – Lundholm & Sloan Chapter 1 - Introduction Focus of the Book – Equity Valuation Business ActivitiesOperating Investing Financing Equity Valuation Theory Dividend Discounting Model o The value of an equity security is equal to the present value of the future cash flows that it will generate o Where Value0 = Value of equity at time 0 Cash Dividendt = expected amount of cash dividends to be paid in period t r = discount rate (cost of capital) Chapter 1 Equity Valuation and Analysis Page 1 of 5 investing and financing decisions and their cash flow effects o Provide a beginning point for forecasting the future Chapter 1 Equity Valuation and Analysis Page 2 of 5 .o Modified Model o Where all from except Stock Repurchasest = expected amount of cash to be paid in period t Equity Issuancest = expected amount of cash to be raised via equity issuances in period t o Of course the challenge is the estimated of the amount and timing of the cash flows So where do financial statements fit into all of this? o Provide a record of the past operating. Valuation • Information Collection • Understanidng the Business • Accounting Analysis • Financial Ratio Analysis • Cash Flow Analysis • Structured Forecasting • Income Statement Forecasts • Balance Sheet Forecasts • Cash Flow Forecasts • Cost of Capital • Valuation Models • Residual Income • Cash Flow • Valuation Ratios • Complications • Negative Values • Value Creation and Destruction through Financing Transactions Chapter 1 Equity Valuation and Analysis Page 3 of 5 .Understading the Past Step 2.Forecasting the Future Step 3 .Equity Analysis Process Step 1 . o Accounting Analysis – Understanding a firm’s accounting policies and estimates o Financial Ratio Analysis – Using financial statements to gain insight into the financial structure and performance of the business – mostly focused on the balance sheet and income statement o Cash Flow Analysis – Understanding the operating. industry and economic analysis o Understanding the Business – What is the company’s strategy.Understanding the Past o Information Collection – SEC reports. investing and financing decisions and their cash flow impact by reviewing the cash flow statement Chapter 1 Equity Valuation and Analysis Page 4 of 5 . press releases. etc. who are its main competitors. Balance Sheet. Also includes forecasting EPS. Also includes ratio analysis of pro forma statements.Forecasting the Future o Structured Forecasting – forecasting key financial ratios and then using this information to forecast financial statements. and Statement of Cash Flows. Valuation o Cost of Capital – What discount rate should we use to determine the present value of the future cash flows o Models Residual Income (earnings based) Discounted Free Cash Flow (cash flow based) o Valuation Ratios – useful to determine over or under priced stocks o Complications Negative equity values Financing transactions that create or destroy value Chapter 1 Equity Valuation and Analysis Page 5 of 5 . o Forecasted (pro forma) Financial Statements – Income Statement.
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