Corporate Valuation and Risk Management of Woolworth Company - Example

Corporate Valuation and Risk Management of Woolworth Company Name Institution Instructor Course Code Due Date Corporate Valuation and Risk Management of Woolworth Company Introduction The Woolworth Company is a US based retail company that is one of the most prosperous five and dime stores currently. This is attributed to its trend strategy, and setting of modern retail model in line with today’s setting. It has established branches in most countries in the world. This is the company that is chosen for this valuation using various valuation alternatives. Estimation of the value of this company first needs the estimation of the cost of capital and comparison with its capital structure. Smith (1988) argues that the estimation process will also consider the potential errors that may be associated with it. This report utilizes valuation of free cash flow to the firm through steady growth and discrepancy growth. The analysis will also consider price. This report takes into consideration the various valuation methods that are relevant to increase our awareness of the company’s position in the market (Daves and Shrieves 2004). The report uses two techniques of valuing the cash flows to the company; dividend discounted forms and the free cash flow to equity. Discount models Expected return on capital is computed using the following formula Cost of equity = Risk free rate of return + payment expected for risk. Cost of equity = Risk free rate of return + Beta x (market rate of return- risk free rate of return). where Beta= sensitivity to actions in the applicable market. Where Es= the expected return for the security Rf= expected risk free premium. Bs= market susceptible risk. Rm= historical return of stock. Rm-Rf = the risk payment over the risk free assets. Es =?, Rf=5.7,. Bs= 0.8, Rm=5.5 5.7+0.8(-0.2)=5.64 Price-To-Book Ratio - P/B Ratio' This ratio is used to make informed assessment of the stock market value. It is calculate a percentage used to estimate a stock's market price to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share (Frykman and Tolleryd 2003). Calculated as: P/B Ratio=? Stock price =$125.50, (total assets- intangible assets and liabilities is = 12,941.00 - 1,379.00) 125.50/11562= 0.011or 1.1% 'Price-Earnings Ratio - P/E Ratio' This valuing procedure matches the present-day share price to the earning s per share. Calculated as: Market Value per Share Earnings per Share (EPS) Market value per share=125.50 Earnings per share=$800.0 125.5/800= 0.2 or 20%. Valuation using (FCFF). The valuation of this company on the FCFF discount model is based on two key assumptions. The company is anticipated to first have a raise in expansion in its original stage and then drop eventually at steady growth rate at the end of period1. The model therefore values the firm based on two key perspectives of growth; higher initial growth and stable growth in the preceding periods. Frykman and Tolleryd (2003) argue that, in order estimate the growth of this company, the most essential inputs to the model are: the expected growth, the length of the high growth period, expected growth rate earnings, inputs from cost of capital, capital spending, depreciation and working capital. There are various methods used in the valuation of a firm but our analysis will only focus only on few growth models (Davis and Jarvis 2007). It is possible to also use different methods such as comparative valuation system and relating firms to one another. Alternatively, the firm can be valued based on an absolute estimate. It is also feasible to arrive at the firm’s value through the use of outstanding income method. This report will discuss various approaches used in valuing Woolworth Company and their underlying basic of firm’s value determination. The methods focused are constant growth model, differential growth model, WACC, FCFF and CAPM. Constant growth model. This model is used to control the existing price of a share relative to its dividend payments, the projected growth rate of these dividends, and the mandatory rate of return by stockholders in the market. Differential growth model. This model assumes that the cash flow matures at a steady rate, and in perpetuity. This makes the dividends a constant rate. It also requires that a typical model be constructed to approximate gains that are expected to change at variable rates for the foreseeable future. FCFF of Woolworth Company focuses mainly on cashflws of all the investors taking into consideration the value of equity (Hooke 2010). It also assumes that the market cost of the debt is equal to the value of debt. FCFF has been projected for last five year period using the company data. This variable has been estimated through the use of historical growth rate, the industry growth rate and competitor’s growth rate. The analysis has also made adequate comparison of the market value of stock and debt. Errors associated with the discount rate calculation and the riskiness Woolworth Company can be attributed to the calculations based on the wrong risk free rate. It mainly occurs through the use of risk free rate. Meitner (2006) argues that forecasting does not necessarily adopt the use of historical rate. In this valuation, this error has been avoided through the use of short term government bond and the use of CAPM to calculate the returns on the treasury bills. It has also utilized the internal rate of return on the bonds. Other errors experienced are due to the use of wrong beta or the risk factor. It is therefore essential that any such calculations should minimize the use of historical average betas. The assumptions that contribute to this risk are the generalization of the risk (Olson and Wu 2008). This occurs when the historical risk calculated is assumed to represent the entire industry. Computation errors may also be experienced when the person carrying out the evaluation uses the wrong formula. The estimation on this report on Woolworth Company uses book value beta. Conclusion The report indicates that Woolworth Company’s cost of capital stand at 5.2%, the price earnings per share is 0.2 0r 20%. This shows that the company is growing at slower pace and its shareholders earnings will decrease with time. According to Conrow (2003), proper measures should be put in place to curb this challenge. The estimated risk premium should be accurate in order to bring accurate results. The accuracy of the entire valuation can be enhanced through proper estimation and not mere subjectivity. References Chicago, Ill, American Bar Association, produced jointly by the Law Practice Management Section and Center for Professional Responsibility. Conrow, EH 2003, Effective risk management: some keys to success. Reston, Va, American Institute of Aeronautics and Astronautics. Daves, PR, Ehrhardt, MC, & Shrieves, RE 2004, Corporate valuation: a guide for managers and investors. Mason, Ohio [u.a.], Thomson/South-Western. Davis, AE, & Jarvis, PR 2007, Risk management: survival tools for law firms. Frykman, D, & Tolleryd, J 2003, Corporate valuation: an easy guide to measuring value. New York, Financial Times Prentice Hall. Hooke, JC 2010, Security analysis and business valuation on Wall Street: a comprehensive guide to today's valuation methods. Hoboken, N.J., Wiley. Meitner, M 2006, The market approach to comparable company valuation; with 26 tables. Heidelberg, Physica-Verl. Olson, DL, & Wu, DD 2008, Enterprise risk management. Singapore, World Scientific. Smith, GV 1988, Corporate valuation. New York, Wiley. Read More