Essay on Laura Martin: Real Options and the Cable Industry

Valuation is the estimation of an asset’s value, whether real or financial, based on variables perceived to be related to future investment returns, on comparison with similar assets, or, when relevant, on estimates of immediate liquidation proceeds (Pinto, Henry, Robinson, Stowe; 2010). Correct valuation of real assets can present challenges to financial analysts. Different models can be used to arrive at the closest estimate of value and yet certain issues will always arise. This case attempts to tackle two approaches in real asset valuation: Discounted Cash Flow (DCF) analysis and the issues surrounding such, as well as the Black-Scholes Model for Real Options. Questions to be addressed in the study are:

When analysts question a firm’s earnings quality, it raises concerns regarding under or over aggressive accounting practices that may be allowing the firm to manipulate the earnings. Earnings quality is defined as the strength of the current earnings in being used to predict future earnings and cash flows. Since earning quality is indicative of future performance, analysts are more likely to address issues that have substantial impact on the earnings quality. An issue arises when the nature of the earnings is questioned. While permanent earnings are part of normal operations, any irregular, one time earnings can skew the earnings, making the firm look more profitable than it is. This is due to the inability to recreate similar one-time transactions that will give rise to such numbers. Investors prefer predictable

He can use two methods to determine the value of the company: discount cash flow (DCF) approach and /or comparison with similar companies, which are publically traded.

in our calculations, as this company exhibited dramatic value differences to others in the sample, (likely to skew our results and prove misleading). Using the average of the revised sample field for each ratio, we inserted Torrington’s values where appropriate to generate an entity value. The findings generated two values for Torrington, 606 million and 398 million. Taking the average of these two numbers, Torrington exhibited a relative value of 502.41 million. Because of the lack of related information given in the case, and the often large differences in measures amongst competitors, different capital structures, internal management strategies, there remained many unknowns in our model. We decided it would be best to use this valuation to reaffirm our assumptions in our DCF valuation. (Please see exhibits)

I have pursued my interest and knowledge of financial markets through analyst positions on Limestone Capital and Queen’s Private Capital Group, two student-run finance clubs at Queen’s. As part of my involvement, I completed training in financial modelling, developing the necessary skills to perform valuations. I also

$18. 30 Day’s high $17.55 trade time Apr 22, 2017, Days low $17.55 trade time change- 1.14% at 52-week high $22.51 the previous close 17.40 and low at 52-weeks $13.06 open at 17.30 the Beta 0.74 The volume was 53.823 Avg.vol 112.122 looking at the above figures the stock they are in a good position. One of their competitors is Amazon. Both companies are star rating the stocks are doing great. Overstock have had a constant and sturdy growth. The online retail giant is a threat to brick-and-mortar stores. Theirs some negative profitability, rising cost and some feel overstock price, put them in a danger zone with the stock market. Overstock up against the competitor such as Amazon, and Wayfair has declined some but not a lot. They have not deteriorated to the point they are in trouble with stock. The profitability of overstock is growing 13% compounded annually from 2002 through 2016; they have lost yet

Zack’s recently downgraded the share price from a buy to a hold, while analysts at Canaccord Genuity continue to keep a buy rating on the stock with a price target of $27 per share. Out of five analysts polled, four of the five place a buy recommendation on the stock with a price target of $26 to $27 per share.

In spite of a recent share price rally, DIS stock also appears undervalued considering its lower valuation compared to the industry average. Its stock is trading around 19 times to earnings and 4 times to book ratio, when the industry average is hovering around 21 and 4.4 times, respectively.

The Black Scholes Merton (BSM) model is the best-known model for valuing options as it is the original of many option pricing models today (Haug and Taleb, 2009; Le, 2015). Developed in 1973 by Fisher Black, Myron Scholes and Robert Merton, the BSM model is still widely used today as the benchmark for many models and techniques that financial analysts use to analyse and determine the fair prices of given options (Jumarie, 2010). It is widely used due to its simplicity however there are many criticisms regarding the assumptions made by the model (Bharath and Sumway, 2008; Haug and Taleb, 2009; Le, 2015)

In DCF valuation (Chart 2), long-term growth rate is assumed to be 4%. Change in working capital is calculated as the average of 1997 and 1996 figure and is assumed to be constant for simplicity. Terminal value is valued at $69,398.1 million and NPV is $51,525 million. Stock price will be $37.07, indicating an exchange ratio at 0.46. This is a very conservative valuation as our DCF price is lower than Amoco’s current market price.

Analyzing a company 's operating expenses is often the most important aspect of equity analysis. How well a company generates operating cash flow dictates how well it can satisfy the claims of creditors and creates value for common shareholders. In order to assess this value creation, investors do well by analyzing a company 's operating income, operating cash flow and operating margins.

Abstract The purpose of this thesis is to compare the practical use of the DCF model with the theoretical recommendations. The empirical study is based on eight different DCF models performed by American, European and Nordic investment banks on the Swedish retail company Hennes & Mauritz (H&M). These models are currently being used internally by the corresponding equity research departments to determine the fair value of the H&M stock. The aspects that are studied are regarded as the basic theoretical requirements of the DCF model. The discrepancies

Instead of having the customers pay 1.2 on the first date and 1.05 each on the second and third payment dates, a payment scheme of 1 on October 1987 and 1.15 on August 1988 and April 1989 will make the BP stock offering a better one. Values higher than the payment amounts are what we need since it will allow investors to have payoffs regardless of the movements of the stock price. Compared with the value in Annex 4, the payoff in this recommendation is 0.03648, compared to simply changing the put price, which yields a payoff of 0.00003. If this payment scheme is applied, the breakeven price for the option strike price significantly decreases to around 0.6338.

In particular, small changes in inputs can result in large changes in the value of a company, given the need to project cash-flow to infinity.  James Montier argues that, "while the algebra of DCF is simple, neat and compelling, the implementation becomes a  minefield of problems". He cites, in particular, problems with  estimating cash flows and estimating discount rates. Despite the issues, DCF analysis is very widely used and is perhaps the primary valuation tool amongst the financial analyst community.

Consider Real Option theory as a method to remove some of the risk in capital investments. Helpful assistance and decision