barcode in vb.net source code Estimating the Cost of Capital in Software

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Estimating the Cost of Capital
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clusion is based upon the principle of arbitrage and the law of one price, an advanced practice in finance that professionals use to take advantage of trading opportunities in the market. How do we incorporate this aspect into a valuation In valuing a company, we assume that the long-term assets of the firm are illiquid or are completely devoted to generating future profits and cash flow for the firm. Therefore, long-term assets enter the valuation equation through NOPMs, and investment and depreciation ratios. Long-term liabilities of the company enter the valuation equation when they are subtracted from total corporate value, as shown at the top of Cisco s general pro forma screen. (See Exhibit 6-8.) The most reasonable way to bring the balance sheet more substantially into play is through the difference of short-term assets versus short-term liabilities. So we add short-term assets to the corporate value side of the equation and subtract short-term liabilities from total corporate value. We use this procedure in the valuations that follow.
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Short-Term Assets Cisco
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According to Cisco s balance sheet of July 27, 2002 (Exhibit 5-4), it has total current assets of $17.433 billion with $9494 in cash and cash equivalents, $3.2 billion in short-term investments, $1.1 billion in accounts receivable, $880 million in inventories, $2 billion in deferred tax assets, and $700 million in miscellaneous current assets. This is a very strong short-term asset base.
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Short-Term Liabilities Cisco
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Cisco s current liabilities total $8.375 billion, so Cisco s current asset/current liability ratio is greater than 2.0 a good level of liquidity. Cisco s largest category of short-term liabilities is deferred revenue of $3.1 billion, followed by accrued compensation of $1.3 billion, $579 million in income taxes payable, $470 million in accounts payable, and $2.8 billion in other accrued liabilities.
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Valuation Inputs Relating to Short-Term Assets and Liabilities Cisco
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Our initial inputs for the ValuePro 2002 software relating to Cisco s short-term assets and liabilities are: Short-Term Assets ($mil) Short-Term Liabilities ($mil) $17,433 $8,375
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STREETSMART GUIDE TO VALUING A STOCK
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EXHIBIT 6-6
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Cisco s General Input Screen
Valuation Exercise: Cisco
We enter the inputs that we discuss above for Cisco into the ValuePro 2002 software, which creates Cisco s general input screen (Exhibit 6-6), Cisco s weighted average cost of capital screen (Exhibit 6-7), and Cisco s general pro forma screen (Exhibit 6-8). Cisco s WACC is 10.04 percent, equal to its cost of equity. Each of Cisco s expected free cash flows, shown in column 11 of Exhibit 6-8, is discounted at the WACC of 10.04 percent. The discount factors, shown in column 12 of Exhibit 6-8, range from [1/(1.1004)]
EXHIBIT 6-7
Cisco s WACC Screen
Estimating the Cost of Capital
EXHIBIT 6-8
Cisco s General Pro Forma Screen
.9088 for year 1, to [1/(1.1004)10] .3841 for year 10. The residual value is equal to $48,268 million and is shown at the bottom of column 13 in Exhibit 6-8. Recall the calculation of corporate value from 4: Corporate Value Cash Flow Operations Residual Value
Short-Term Assets
This calculation, shown at the top of Exhibit 6-8, has a total corporate or enterprise value of $89,314 million. Also recall from 4 the calculation of common stock value: Value to Common Equity Corporate Value Debt Preferred Short-Term Liabilities
This calculation also is shown at the top of Exhibit 6-8, and shows a value to common equity of $80,939 million, along with per share intrinsic stock value of $10.87.
After the Cost of Capital The Next Step
In this chapter we have explored the estimation of the rate that s used to discount the estimated free cash flow to the firm. We have looked at the calculation of the weighted average cost of capital, and discussed how to estimate the costs of common equity, debt, and preferred stock.
STREETSMART GUIDE TO VALUING A STOCK
We have examined the WACC calculation for a company with a complex capital structure, ConEd, in Exhibit 6-5. We have also shown how the WACC for a company with only common stock outstanding, Cisco, is handled by a simple CAPM equation that computes the cost of common equity. We have also seen that using market value for common stock, and book values for debt and preferred stock, is a generally accepted practitioner s way of calculating the WACC of a corporation. In 7, we explain where and how an investor can quickly find the information needed to use the DCF approach and make informed, intelligent valuations. Armed with this information, our savvy investor will be ready to conquer the investment world!
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