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**Models**

Damodaran on Valuation:1994

Security Analysis for Investment and Corporate Finance,

Aswath Damodaran

New York: John Wiley & Sons.

These excerpts and quotes are considered to be "fair use" as interpreted byThe Chicago Manual of Style: The Essential Guide for Writers, Editors, and Publisher, 14th edition, 1993. Chicago: The University of Chicago Press.

Contents

Preface

-- Outline of the Book

>>Note: Chapter 1 of this book examines the general basis for valuation models and the role that valuation plays in different investment philosophies. Chapter 2 provides an overview of the three basic approaches to valuation: discounted cash-flow valuation, relative valuation, and contingent-claim (option pricing) valuation. The rest of the book delves into the details of using these models.

Chapter 1: Introduction to Valuation

Chapter 2: Approaches to Valuation

Chapter 3: Estimation of Discount Rates

Chapter 4: Estimation of Cash Flows

Chapter 5: Estimation of Growth Rates

Chapter 6: Dividend-Discount Models

Chapter 7: Free-Cash-Flow-to-Equity Discount Models

Chapter 8: Valuing a Firm--The Free-Cash-Flow-to-Firm Approach

Chapter 9: Special Cases in Valuation

§1 Cyclical Firms

§2 Firms in Financial Distress

§3 Firms with Product Options

§4 Private Firms

§5 Conclusion

Chapter 10: Price/Earnings Ratios

§1 The Use and Misuse of P/E Ratios

§2 Estimating P/E Ratios from Fundamentals

§3 Comparisons of P/E Ratios

§4 Problems with P/E Ratios

§5 Variants of the P/E Ratio (accounting earnings, cash flows, pretax, after-tax)

§6 Price/Dividend Ratios and Dividend Yields

§7 P/E Ratios and Stock Returns

§8 Conclusion

Chapter 11: Price/Book Value Ratios

Chapter 12: Price/Sales Ratios

Chapter 13: Management Decisions, Corporate Strategy, and Firm Value

Chapter 14: Valuation for Acquisitions and Takeovers

Chapter 15: Option-Pricing Theory

Chapter 16: Application of Option-Pricing Theory to Valuation

Chapter 17: Overview and Conclusion

-- Choices in Valuation Models

-- Determinants of Choice--DCF Models

-- Determinants of Choice--Relative-Value Models

-- Conclusion

>> Note: The analyst faced with the task of valuing a firm or its equity has to choose between three different approaches: DCF valuation, relative valuation, and option-pricing models; and within each approach, between different models. This choice will be driven largely by the characteristics of the firm being valued: the level of its earnings (positive or negative, normal or abnormal), its growth potential (relative to the economy in which it operates, e.g., stable, moderate-growth, or high-growth), the sources of earnings growth (specific or general), the stability of its leverage (stable or unstable, either increasing or decreasing toward its optimum), and its dividend policy. Matching the valuation model to the asset or firm being valued is as important a part of valuation as understanding the models and having the right inputs.

Appendix 1: The Capital Asset Pricing Model

Appendix 2: Historical Returns on Stocks, T.Bills, and T.Bonds

Appendix 3: Valuation Models

-- Notation Used in Valuation Models

-- 1. The Gordon Growth Model

-- 2. The Two-Stage Dividend-Discount Model

-- 2a. The Value of Growth

-- 3. The H Model for Valuing Growth

-- 4. The Three-Stage Dividend-Discount Model

-- 5. The Stable-Growth FCFE Model (Free Cash-Flow to the Equity)

-- 6. The Two-Stage FCFE Model

-- 7. The E Model--A Three-Stage FCFE Model

-- 8. The FCFF Stable-Growth Model (Free Cash-Flow to the Firm)

-- 9. The General Version of the FCFF Model

-- 10. Price/Earnings Ratios--Fundamentals

-- 11. Price/Book Value Ratios--Fundamentals

-- 12. Price/Sales Ratios--Fundamentals

-- 13. Option-Pricing Model--Valuing Equity

-- 14. Option-Pricing Model--Valuing Natural Resources

-- 15. Option-Pricing Model--Valuing Product Patents as Options

References

Disk Documentation

Index

Corporate Finance: Theory and Practice, 1997Aswath Damodaran, Stern School of Business, New York University

New York: John Wiley & Sons

Contents

Part I. An Introduction to Corporate Finance

Part II. Investment Analysis

Part III. The Financing Decision

Part IV. The Dividend Decision

Part V. Valuation

>> Note:The fifth section of the book links the investment, financing and dividend decisions to the value of the firm. Chapter 23 provides an introduction to discounted cash flow models for value and relative valuation models (such as multiples) and the reasons for the differences between the two approaches. Chapter 24 extends this discussion to look at corporate restructuring effects on value, and value enhancement strategies being adopted by many firms. Chapter 25 discusses the special issues relating to valuing mergers, including the value of control and synergy.Chapter 23. Basics of Valuation

Chapter 24. Management Decisions, Corporate Strategy, and Firm Value

Chapter 25. Acquisitions and Takeover

Part VI. Other Tools and Techniques

>> Note: It is my hope that the extended examples in this book will induce readers to try out the theory on other companies. By doing so, they will not only understand the limitations of the theory better, but also learn how to adapt it for use in the real world. To make this process easier, there is a accompanying diskette containing spreadsheets that were used to generate the applications in this book. Readers should be able to use these spreadsheets to analyze a project, examine the optimal debt ratio for a firm, estimate how much cash it has available to pay out to stockholders and value the firm.

Link toWiley College: Damodaran Corporate Finance

THIS IS A LIST OF EXCEL PROGRAMS THAT YOU MIGHT FIND USEFUL. THEY ARE NOT COPY PROTECTED. FEEL FREE TO MODIFY THEM TO YOUR OWN NEEDS.

Note: These lists do NOT contain active hyperlinks. Click on the above link to Wiley College to reach the list of active hyperlinks to models.

Corporate Finance Spreadsheets

1.capbudg.xls: This program allows you to do a basic capital budgeting analysis for a project, and compute NPV, IRR and ROI. (ForMacintoshversion)

2.risk.xls: This program allows you to use past returns on a stock and a market index to analyse its price performance (Jensen's Alpha), its sensitivity to market movements (Beta) and the proportion of its risk that can be attributed to the market.(ForMacintoshversion)

3.capstru.xls: This program allows you to estimate an "Optimal" Capital structure for a company using the cost of capital approach , the differential return approach and the APV approach. (For Macintosh version)

4. capstruo.xls: This is a variant that allows you to estimate an "Optimal" capital structure for a company whose operating income might vary with its debt rating - for instance, financial service firms. (ForMacintoshversion)

5.dividends.xls: This program compares the dividends paid to what a firm could have paid, by estimating the free cash flow to equity (the cash flow left over after net debt payments, net capital expenditures and working capital investments.(ForMacintoshversion)

6.dcfval.xls: This program computes the value of equity in a firm using a two-stage dividend discount and FCFE model. (For more extensive choices on valuation, look at the programs under the valuation section below.) (ForMacintoshversion)

7.lboval.xls: This program analyzes the value of equity and the firm in a leveraged buyout. (For Macintosh version) 8.synergy.xls: This program estimates the value of synergy in a merger. (ForMacintoshversion)

Equity Valuation Spreadsheets

1.readme1s.xls: This file describes the programs in this section and provides some insights into their usage. (ForMacintoshversion)

2.model.xls: This program provides a rough guide to which discounted cash flow model may be best suited to your firm. (ForMacintoshversion)

3.ddmst.xls: Stable growth, dividend discount model; best suited for firms growing at the same rate as the economy and paying residual cash as dividends. (ForMacintoshversion)

4.ddm2st.xls: Two-stage DDM; best suited for firms paying residual cash in dividends while having moderate growth. (ForMacintoshversion)

5.implprem.xls: This spreadsheet calculates the implied risk premium in a market. This can be used in discounted cashflow valuation to do market neutral valuation.

6.ddm3st.xls: Three-stage DDM; best suited for firms paying residual cash in dividends, while having high growth. (ForMacintoshversion)

7.fcfest.xls: Stable growth, FCFE discount model; best suited for firms in stable leverage and growing at the same rate as the economy. (ForMacintoshversion)

8.fcfe2st.xls: Two-stage FCFE discount model; best suited for firms with stable leverage and having moderate growth. (ForMacintoshversion)

9.fcfe3st.xls: Three-stage FCFE discount model; best suited for firms with stable leverage and having high growth. (ForMacintoshversion)

10.fcffst.xls: Stable growth FCFF discount model; best suited for firms growing at the same rate as the economy. (ForMacintoshversion)

11.fcff2st.xls: Two-stage FCFF discount model; best suited for firms with shifting leverage and growing at a moderate rate. (ForMacintoshversion)

12.fcff3st.xls: Three-stage FCFF discount model; best suited for firms with shifting leverage with high growth. (ForMacintoshversion)

13.fcffgen.xls: A generalised FCFF model, where the operating margins are allowed to change each year; best suited for firms in trouble or transition. (ForMacintoshversion)

14.equity.xls: A model that uses option pricing to value the equity in a firm; best suited for highly levered firms in trouble. (ForMacintoshversion)

15.natres.xls: A model that uses option pricing to value a natural resource company; useful for valuing oil or mining companies. (ForMacintoshversion)

16.project.xls: A model that uses option pricing to value a product patent or option; useful for valuing the patents that a company might hold. (ForMacintoshversion)

The Damodaran valuation models are spreadsheet models and are presented with

market betaand thus are market-basedpricingmodels and not market-independentvaluationmodels. They can be valuation models if used without the market beta factor to adjust for so-called market risk. TheDCF Valuatoronline interactive graphical investment valuation models are dynamic decision-tree models, not static spreadsheet models, and they use Monte Carlo simulation scenarios for uncertainty.

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