— Finance Theory and PracticeStock Valuation project The purpose of the project is to estimate and justify:  (1) an intrinsic (fundamental) value for the company of your choice and (2) the fundamental price/share of equity in the firm.  You should attempt to justify that you have calculated your best estimate of the firm’s stock price.  You may compare your values (ratios/prices/calculations, etc.) to those you find on the internet, but your work should be your own and your job is to calculate these figures.  All calculations/ratios/values are assumed to have been calculated by you own.  You should not substitute those figures for yours and using such figures from other sources is plagiarism. All of your reports (including table, graph, figures, reference, etc) should not be longer than 25 pages. You may use up to three different methodsto calculate firm stock value (the FCF method is most important and you have to include this analysis in your project).   The three methods that we study for valuing corporations include: 1. Free Cash Flow Method (or discounted cash flow method).   This method requires you to produce pro forma financial statements as based upon the additional funds needed, percentage of sales and constant ratio methods (see “Financial forecasting” in the index).  The pro forma statements are then used to calculate the free cash flow as based upon the formulas/examples in the:  "Financial Statements, Cash Flow and Taxes," "Financial Planning and Forecasting Financial Statements," and the "Corporate Valuation," chapters in the text.  The FCF is discounted back to the present by the WACC, which leads to the firm value as follows.  Note that the present value of the FCFs =  the Value of Operations (see the CH 7 and the formula runs as followings). Value of Operations (Enterprise Value ) +  Value of non-operating assets  (one example would be marketable securities) =  Total Firm value -   Value of Debt  [we use the book value of ST and LT debt; though theory suggests that the market value -    Value of Preferred Shares   [if any]   =   Value of Equity ÷ Number of Shares of Common Stock outstanding Price per share This price per share is your estimate of the fundamental value of the firm stock, which you would then use to argue that the firm is either currently over/under/fairly valued according to the market, i.e., by comparing your price/share to the current market price/share.  Warren Buffet calls this estimate the "intrinsic value" of the firm.  Remember that you may consider the efficient market hypothesis in relation to your price estimate. 2. Dividend Growth Model (Multi-stage growth model) 3. Comparables (Stock Price Multiples Model):  This method is relatively easy and provides some useful valuations that often set the ranges for the stock price.  The course packet lecture entitled “Using Stock Price Multiples to Estimate Stock Price” describes this method.  You may use either a direct competitor or industry averages. .

1. — Finance Theory and PracticeStock Valuation project
The purpose of the project is to estimate and justify: (1) an
intrinsic (fundamental) value for the company of your choice
and (2) the fundamental price/share of equity in the firm. You
should attempt to justify that you have calculated your best
estimate of the firm’s stock price. You may compare your
values (ratios/prices/calculations, etc.) to those you find on the
internet, but your work should be your own and your job is to
calculate these figures. All calculations/ratios/values are
assumed to have been calculated by you own. You should not
substitute those figures for yours and using such figures from
other sources is plagiarism. All of your reports (including table,
graph, figures, reference, etc) should not be longer than 25
pages.
You may use up to three different methodsto calculate firm
stock value (the FCF method is most important and you have to
include this analysis in your project). The three methods that
we study for valuing corporations include:
1. Free Cash Flow Method (or discounted cash flow
method). This method requires you to produce pro forma
financial statements as based upon the additional funds needed,
percentage of sales and constant ratio methods (see “Financial
forecasting” in the index). The pro forma statements are then
used to calculate the free cash flow as based upon the
formulas/examples in the: "Financial Statements, Cash Flow
and Taxes," "Financial Planning and Forecasting Financial
Statements," and the "Corporate Valuation," chapters in the
text. The FCF is discounted back to the present by the WACC,
which leads to the firm value as follows. Note that the present
value of the FCFs = the Value of Operations (see the CH 7 and
the formula runs as followings).
Value of Operations (Enterprise Value )
+ Value of non-operating assets (one example would be
marketable securities)

2. = Total Firm value
- Value of Debt [we use the book value of ST and LT debt;
though theory suggests that the market value
- Value of Preferred Shares [if any]
= Value of Equity
÷ Number of Shares of Common Stock outstanding
Price per share
This price per share is your estimate of the fundamental value
of the firm stock, which you would then use to argue that the
firm is either currently over/under/fairly valued according to the
market, i.e., by comparing your price/share to
the current market price/share. Warren Buffet calls this
estimate the "intrinsic value" of the firm. Remember that you
may consider the efficient market hypothesis in relation to your
price estimate.
2. Dividend Growth Model (Multi-stage growth model)
3. Comparables (Stock Price Multiples Model): This method is
relatively easy and provides some useful valuations that often
set the ranges for the stock price. The course packet lecture
entitled “Using Stock Price Multiples to Estimate Stock Price”
describes this method. You may use either a direct competitor
or industry averages. For example, if you are analyzing Ford
Motor Corp. it would be appropriate to use GM as a comparable
firm (and/or the auto industry). Note that sector/industry ratios
can be obtained on Yahoo.finance [look under profiles, then on
the left hand side under Financial Links you should
see competitors]. Many different financial ratios can be used,
although the P/E and Price/CF ratios are common. Another
alternative is to create your own "industry" averages from a
diverse group of firms within the industry. You are limited
only by your creativity; and a great deal of information is
available on the Internet. The goal should be to calculate
fundamental values by yourself.

3. General Guidelines(Mandatory)
The major focus of the project is to calculate and justify your
estimate of the price/share of equity using the FCF
Method. Many other elements of the project are necessary in
order to complete a satisfactory project. Minimally, these
include:
An example is given on CH12 (page 489- 495).
Completing 5-year pro-formas for your firm. The pro formas
serve as the central element of your project. Many steps lead up
to the pro formas, and many important steps follow from the pro
forma. All of your estimates should include
appropriate justification/ support/ explanation. Many of the
estimates of growth rates and ratios needed below should be
calculated using regression analysis.
Growth. You will need to calculate the historical growth
in dividends or in revenue for your firm (in order to obtain an
estimate of future growth). The method for estimating growth
is illustrated by an example of dividend growth for Firm XXX.
– the related file is provided on Blackboard (BB) by the name
of “Growth estimate sheet”.
Data Needed to Construct the Pro Formas
* Dividend data: You can attain the historical data from
https://www.dividata.com/
*An Excel spreadsheet that you use to construct your pro
formas. An excel file is provided on BB and here under the
name: CH12 (Figure 1-3) . This file “automatically” completes
the 5 years of pro formas for you; given that you have input the
data and assumptions correctly.
* 2 years of the firm’s historical financial statements,
including annual balance sheets, income and cash flow
statements (these form the basis of your pro formas). You may

4. also want to download 5-10 year historical data to do a better
estimate. This data may be downloaded at Mergent-
Online (available through the university library) or through the
SEC official site:
http://www.sec.gov/edgar/searchedgar/companysearch.html
NOTE: While you may want to read or skim the 10Ks for your
company, you need not construct the 10 years of financial data
from the 10Ks. Rather, using either SEC site or MergentOnline,
you are able to download the 5-10 years of financial statements
directly as a file which can be read by Excel. Should you have
difficulty, please contact me.
* Estimates of the company’s current and future (long-term
normal – gn ) sales growth (this should be completed in the
same manner that you calculate dividend growth for a company)
– you may use the Growth estimate sheet available on
Blackboard as a guide. Use the 10 years of financial
statements for the historical sales figures.
* A justification of your choice of constant or non-constant
ratios when completing the pro-formas (the base case should
usually be the constant ratio approach as discussed in the text).
* An estimate of the firm’s target capital structure (see the
guideline below about Calculating a Firm’s WACC) – note that
you need these weights both for the WACC.
* An estimate of the firm’s dividend payout policy.
* The firm’s tax rate.
Steps to Take after Completing the Pro Formas
* As mentioned above, the goal is to calculate the firm’s
value (in the end, your estimate of the stock price/share). This
requires that you calculate the firm’s FCFs (free cash flows) as
discussed in the relevant chapters in your text (CH2 and
CH12). This should be a relatively easy procedure, and should
be done on the same Excel spreadsheet as your pro-formas (see
CH12 (Figure 1-3)).

5. * You also need to calculate the Continuing Value (or
terminal or horizon values) as discussed in CH6 - see the related
equation (it is analogous to the constant growth part of the
supernormal growth model)! This is a crucial part of the
project, because the continuing value of the firm will typically
be the largest proportion of any firm’s current value.
* To discount the FCFs back to the “present” (to the date
of your last historical financial statements) you need to have
an estimate of the firm’s WACC(note that this includes the
weights of debt and equity, the costs of debt and equity, the
latter of which is calculated by using the CAPM, with your
estimate of the firm’s beta). Again, see the guidelines of
WACC Calculationabout Calculating a Firm’s WACC, and also
review the “Four Mistakes to Avoid” (see the index to your
text).
* Once you have completed these steps, you are then ready
to follow the general steps described above to calculate your
estimate of the stock price/share.
Improving the Quality of your Project(Optional)
Other elements are left up to you, in terms of how complete
and/or creative you want your project to be. Some of these
elements must be completed in order to earn a higher than
average or satisfactory evaluation for the project. You
may/should include these other elements if you believe that they
will improve your “case” for your estimate of the price/share
for your firm. For example, a SWOT analysis is often used in
business. For this project, it may be useful, but only if you can
connect the main conclusions of the SWOT analysis to your
evaluation of the firm.
The most important extensions include:
* Using ratios that are not a constant percentage of sales
when constructing the pro formas (the basic percent of sales

6. method is described in the Financial Planning and Forecasting
Financial Statements chapter of the text). The relevant
procedures are either discussed in the text or are available on
spreadsheets that come with the text and/or are on the text's
homepage (listed in the syllabus). The firm’s profit margin has
a very important impact on firm value. If you use the most
recent profit margin in the pro formas, you may not be
providing an accurate longer-term picture of the firm’s
operations. As a result, it may be useful or even crucial to
analyze this ratio and/or others when constructing the pro
formas.
* Sensitivity analysis. How does your estimate of the
price/share change with changes in the firm’s WACC, the firm’s
short or long-term growth rates, changes in the firm’s profit
margin(s) and so on. The amount of work that could be done
here is almost limitless, so good projects would demonstrate
good judgment in which sensitivity analyses they conduct.
* Scenario analysis. This is similar to sensitivity analysis,
but discrete scenarios (e.g., a recession or a boom) are analyzed
instead.
* Ratio analysis. Ratios can be used as diagnostic tools in
evaluating the “health” of a firm. Note that such analysis would
typically include comparisons of your firm’s financial ratios to
the industry standards (or averages). These averages are
available on the Yahoo.finance site
under: Profile/Competitors (Sector or Industry). Ratio analysis
by itself is not very useful in terms of valuation. It provides a
diagnostic view of the company which may be helpful in terms
of analyzing the better and poorer practices of a company. In
order to make ratio analysis relevant for this project, it must be
tied directly to the firm's valuation. For example, if a
company's current Inventory Turnover is very poor, the group
can suggest that it should get better into the future, and then
make the necessary adjustments (which may require changes in

7. the formulas) in the pro forma sheets, to see how improving the
inventory turnover would increase the firm's value.
Advanced Elements of the Firm Valuation Project If you
attempt any of the following, you should connect the additional
analysis directly to the base case for your firm valuation
project.
* Managerial/Strategy Analysis. You may view your job of
this project as the managers of the firm. In completing the
project, you may recognize that the company is either
performing some function very well or very poorly. It is
perfectly appropriate to make suggestions for improving or
maintaining the operation of the firm.
* Marketing Analysis. Future sales typically depend upon
marketing. Projects which focus on companies for which this
may be particularly important may consider analyzing the
marketing policies of the company in order to determine how
those policies affect firm value.
12. Exactly how do you plan on closing the deal?
LEARNING EXERCISE: HEIRS TO AN ESTATE
Recently you and your brother and sister inherited the estate of
an aunt who lived in
Chicago. All three of you loved your aunt, but even though you
all bved in the same
city, you had not kept in contact in recent years due to career
and family obligations.
Your aunt's last will and testament requires that the three of you
divide her assets

8. any way that you can agree upon within 30 days of her death.
However, if you fail to
provide her attorney with a written agreement within the 30
days, all of her assets
will be given to charity. The estate consists of the following:
(1) about $320,000 in
cash and Certificates of Deposit; (2) a 2004 Lincoln Town Car;
(3) two houses, valued
at $360,000 and $525,000; (4) all of the furnishings of both
houses; (5) an art collection
valued at $250,000; (6) season tickets to the Chicago Cubs
(behind the home dugout);
and (7) a large box containing family photos and slides. The
three of you are meeting
in six days to negotiate a settlement. In preparation, ask
yourself the following skills
questions:
Skill2.1: Recognize that before next week's meeting,
preparation is critical to
success, and usually includes identifying all tangible and
intangible
issues that will be of interest to either party, and then
prioritizing those
issues, making sure to include some throwaway issues. What
prepara-
tions do you need to make before the meeting?
Skill 2.2: Should you propose that the three of you begin
negotiation by adopt-
ing ground rules that address the "5 W" questions; Who, What,
Where,
When, and How? Also, carefully consider the 1'who"-will
spouses
and children be included, and the "where" or the setting-where
should you meet?

9. Skill2.3: The initial offer in negotiation could affect the tone
and outcome. What
will be your initial offer?
Skill 2.4: Anticipate some posturing by your brother and sister.
While the three
of you get along fairly well, this estate represents a great deal
of money
for each family. What posturing might you encounter?
Skill 2.5: Decide whether you are primarily negotiating a
single-issue or a multi-
ple-issue situation, and choose an appropriate strategy. Should
you
consider a third-party intervention?
52 Chapter 2 The Negotiation Process: Four Stages