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models discount

In finance, the value of a property is the value of future cash flows that we will release the property in today's dollars. For example, a government bond that will give me $ 100 in 12 months could claims $ 98 today. For a more detailed explanation of the concept of discounting, see the note on the intrinsic value of a company blog Financial Portfolio.

can be divided into 2 main models types: models of dividends and free cash flow models. In reality, there are hundreds of models that are all derivatives of these basic forms. Therefore in business schools we just normally thereof.


dividend discount models
( Dividend discount model )

As its name suggests, these models update the value of future dividends on the company to determine the intrinsic value of the action. A major flaw is that it assumes that the dividend is the only form of shareholder remuneration. All businesses that pay no dividends (or do not pay in the foreseeable future) are not assessable by these models. But even for companies that pay dividends, it is difficult to clearly assess the value of a share. First, some companies pay dividends irregular, is making complex modeling. Then, several firms have dividends that are not correlated with company performance (and therefore unsustainable in the long term). For example, GM has paid 30% of its profits in dividends in 2000, but 113% in 2001 and paid from 2005 to 2008 despite operating losses. Using a dividend discount model in such a case is without interest.

The first step of a model dividend is to determine if the company lends itself to such analysis. Normally, only mature companies with steady growth and relatively low (we'll see why soon) are good candidates for a model with dividend.

Model Gordon
This is the simplest and most popular of the dividend discount model. To find the price of a stock (P), we need the next dividend (D), the rate of dividend growth (g) and the shareholder's required return (k). The formula is:

The greatest weakness of this model is mathematical. First, k and g must be constant over time. But mostly, kg must be positive and nonzero. However, many companies have an average growth over the past 5 years 20 to 30%. The application of the Gordon model is impossible.

The two-stage model ( Two-stage model )
To overcome the problem of excessive growth, some will prefer to do the evaluation in two stages. First, we will evaluate a series of growth "extraordinary" (ie where g> k) and then create a regular pattern of Gordon. For example, one could say that business will grow 30% annually for 10 years and then return to a normal level of growth (long term) of 8%. Mathematically, the model is written :

The first section (before the +) calculates the value of dividends that are extraordinary growth. The second calculates the value of the Gordon model is the extraordinary growth over time (and, of course, updated to today). gs represents the extraordinary growth rate (short term) with n like many of the period. gL is the rate of growth in the long term.

One weakness of this model is that it directly affects the rate of growth to another. In my example, it would therefore immediately from 30% to 8% overnight. It is for this reason that the next model was created.

Model-H (H-model )
The model assumes H as the previous rate of growth in the short term and long-term rates. But here, we assume that the rate will decrease linearly over the duration. In the numerical example above, the growth of 30% to 8% decrease over 10 years. So the growth rate decrease of 2.2% per year. The model is written:

The variable H is the half-life of extraordinary growth. In my numerical example, H would be 5 (or 10 / 2 !!!).


free cash flow models
( Free cash flow valuation )

As mentioned previously, models of dividends suffer a major problem: they evaluate dividends! One possible change is to use the same models, but replace the variable D CWF (or MLF for free cash flow). How to calculate cash flow? Which make? It is the purpose of this section.


Free Cash Flow the firm (FCFF)
The first type of FML is the FCFF. It gives us the amount of cash flow that are available throughout the enterprise. Its formula is:

Why all these changes in net income (NI variable)? Because creditors and shareholders have no direct access to profits. In fact, some of that profit must be reinvested in the company. Also, part of the profit comes from non-monetary item. Let each of the variables of the formula. First, NCC is for Non-cash charges or, in French, non-cash charges. Often, this item such as depreciation. WCInv is investment in working capital ( Working Capital Investment ). Int represents interest expense and taxes the tax rate. It adds that element because we want to here all cash flows available to all donors of the company. We must add the burden of interest because it belongs to the creditors (but the tax savings remains in force). CAPEX investment is needed in long-term assets (for Capital Expenditures ). It also removes that amount of free cash flow because you have to reinvest the money in the company for its normal functioning. The insightful

have noticed that NI + NCC - WCInv = cash flow generated from operations. We could reduce the calculations by taking directly the number of the statement of cash flows.

As the flow of money we use is for the company, the rate k is taken to the enterprise. Normally, we take the weighted average cost of capital (WACC or WACC in English). Note that the calculation here does not give the share price, but the value of the whole enterprise. Suffice it to remove the value of debt and divide by the number of shares to find a value per share.


free cash flow available to shareholders (FCFE)
The FCFE FCFF is comparable except that it now seeks only the cash flows available for shareholders. Such a calculation has the advantage of keeping the same k that models dividend and give us directly the value of the shares. It will also take into account changes in capital structure already provided as shown by the formula:

The NetBorrowing represents the net of new borrowings. Just subtract the loan repayments to new issues to find the value of NetBorrowing.