Comparing the Corporate Valuation and Dividend Growth Models

Because the corporate valuation and dividend growth models give the same answer, does it matter which model you choose? In general, it does. For example, if you were a financial analyst estimating the value of a mature company whose dividends are expected to grow steadily in the future, it would probably be more efficient to use the dividend growth model. Here you would only need to estimate the growth rate in dividends, not the entire set of pro forma financial statements.

However, if a company is paying a dividend but is still in the high-growth stage of its life cycle, you would need to project the future financial statements before you

4Rather than subtracting the book values of debt and preferred stock, it would be better to subtract their market values. In most cases, including this one, the book values of fixed income securities are close to their market values, and when this is true, one can simply work with book values.

TABLE 12-4 Finding the Value of MagnaVision's Stock

(Millions of Dollars Except for Per Share Data)

TABLE 12-4 Finding the Value of MagnaVision's Stock

(Millions of Dollars Except for Per Share Data)

1.

Value of operations (present value of free cash flows)

$615.27

2.

Plus value of nonoperating assets

63.00

3.

Total market value of the firm

$678.27

4.

Less: Value of debt

247.00

Value of preferred stock

62.00

5.

Value of common equity

$369.27

6.

Divide by number of shares

100.00

7.

Value per share

$3.69

FIGURE 12-3 Using the DCF Dividend Model to Find MagnaVision's Stock Value

12/31/02 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07

SO.OOOO O.OOOO O.2983 3.3974

O.476

5.738

could make a reasonable estimate of future dividends. Then, because you would have already estimated future financial statements, it would be a toss-up as to whether the corporate valuation model or the dividend growth model would be easier to apply. Intel, which pays a dividend of about 8 cents versus earnings of about $0.54, is an example of a company to which you could apply either model.

Now suppose you were trying to estimate the value of a company that has never paid a dividend, such as Microsoft, or a new firm that is about to go public, or a division that GE or some other large company is planning to sell. In all of these situations, you would have no choice: You would have to estimate future financial statements and use the corporate valuation model.

Actually, even if a company is paying steady dividends, much can be learned from the corporate valuation model, hence many analysts today use it for all types of valuations. The process of projecting the future financial statements can reveal quite a bit about the company's operations and financing needs. Also, such an analysis can provide insights into actions that might be taken to increase the company's value. This is value-based management, which we discuss in the next section.

Give some examples of assets-in-place, growth options, and nonoperating assets.

Write out the equation for the value of operations.

What is the terminal, or horizon, value? Why is it also called the continuing value?

Explain how to estimate the price per share using the corporate valuation model.

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Thinking Big and Getting Rich

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