Incremental Working Capital
Working capital is needed to support the sales effort of a company. In the calculation of incremental working capital, we want to find short-term assets and liabilities, the levels of which depend directly on the Projected Net Investment Schedule in millions of dollars amount of revenue. The current assets and current liability categories that most directly relate to sales are accounts receivable monies owed to the company from customers inventories monies used by the company to finance its...
The Discounted FCFF Valuation Approach
The discounted FCFF valuation approach uses a four-step process to value the stock of a company. In this section we value the common stock of Microsoft, at a point in time prior to its announcement on January 16, 2003 of a two-for-one stock split to take effect on January 28th. If you follow along with us closely, you'll quickly learn the basics about valuing a stock. Step 1 Forecast Expected Cash Flow. The first order of business is to forecast the expected cash flows for the company. We use...
Total Risk Systematic Risk Unsystematic Risk
Diversification reduces the unsystematic risk of a portfolio. Remember that on average, the negative stock-specific surprises affecting companies in a diversified portfolio will be offset by positive surprises. TABLE 2-7 How Many Stocks Make a Diversified Portfolio TABLE 2-7 How Many Stocks Make a Diversified Portfolio Average Standard Deviation of Annual Portfolio Returns Ratio of Portfolio Standard Deviation of a Single Stock Table 2-7 summarizes the results of a study8 performed by Meir...
Acknowledgments
The original Streetsmart Guide to Valuing a Stock was conceived and outlined on a trip to Spain. The concepts underlying stock valuation crystallized only as real livestock 6 fighting bulls and 8 steers attempted to run over us on the narrow, crowded streets of Pamplona. Integral to the book's progress were the discussions, over many fine meals with our friends in Navarra, of its structure and international appeal. Ana Vizcay and Eduardo Iriso, Mar a Jesus Ruiz Ciord a and Emilio Goicoechea,...
Return versus Risk Our Recommendation
When deciding whether to buy or sell a stock, we assess whether the probabilities of positive or negative surprises are equal, or whether the probabilities of reward or risk are skewed in a particular direction. Over time, there is a tendency for the return and risk of the markets to revert to their average levels, a concept known as reversion to the mean. For example, the returns on the S amp P 500 over the 1995-1999 period were as follows 37.4 percent, 23.1 percent, 33.3 percent, 28.6 percent...
PV 9434 8900 18334 Marys Mortgage A DCF Example Valuation
To understand the DCF process better, consider a home mortgage. Mary wants to purchase a new house, so she borrows 100,000 from the bank and is the obligor on an 8-percent, 30-year mortgage. The EXHIBIT 3-1 DCF Example for Mary's Mortgage monthly mortgage payment is 734 for 360 months, as shown in Exhibit 3-1. Mary's 734 monthly payments are the cash flows that she is obligated to pay under her mortgage agreement and that the bank expects to receive for lending her the money. Over the life of...
Financial Assets
We assume that you have enough liquid assets to finance six months of expenses and some unforeseen emergencies, and that you have insurance coverage to cover tragedies. In Principle 8, we note that the diversification process begins with asset allocation. Spreading your funds over alternative asset classes reduces the overall risk of your portfolio. We now want to go one step further and get a better understanding of diversification and risk. The key to diversification and risk reduction is the...
Some Definitions Relating to Return and Risk
It's important that we all start on the same page when discussing expected returns and risk. In this section, we define some important terms that relate to the calculation of returns on an asset. We then tackle the thorny problem of understanding risk. Definitions Relating to Return Expected Return on a Risky Asset E i is the rate of return an investor expects to receive on a risky asset over a period of time. The expected return consists of regular cash flow payments, such as dividends on a...