The Value of Operations and the Evaluation of Enterprise Price-to-Book Ratios and Price-Earnings Ratios
The Value of Operations and the Evaluation of Enterprise Price-to-Book Ratios and Price-Earnings Ratios
After reading this chapter you should understand:
How, for an asset at fair market value on the balance
sheet, expected residual income in the future must be
zero.
How a valuation based on forecasting residual income
from operations differs from a residual earnings (RE)
valuation based on forecasting full comprehensive
income.
Why forecasted residual income (or expense) on financial
assets and liabilities is typically zero.
How return on net operating assets and growth in net
operating assets are the two drivers of residual operating
income.
How a valuation based on forecasting abnormal operating
income growth differs from an abnormal earnings
growth (AEG) valuation.
How the required return for operations and the required
return for equity are related.
How financial leverage affects ROCE, earnings growth,
and the required return for equity.
How financial leverage affects a valuation.
Why earnings growth that is created by leverage
should not be valued.
The effects of stock repurchases on value.
The difference between enterprise (unlevered) price
multiples and levered multiples.
After reading this chapter you should be able to:
Calculate residual operating income.
Calculate abnormal operating income growth.
Value a firm using the residual operating income model
and the abnormal operating income growth model.
Identify the drivers of residual operating income.
Use reformulated balance sheets to value the financing
activities of a business.
Analyze the effect of a change in financial leverage on
the value of a firm.
Analyze the effect of financial leverage on ROCE,
earnings growth, equity cost of capital, and P/B and P/E
ratios.
Calculate a weighted-average cost of capital using
market values for debt and equity.
Calculate the cost of capital for equity from the cost of
capital for operations and the cost of debt.
Explain the difference between a levered and unlevered
price-to-book ratio.
Explain the difference between a levered an unlevered
price-earnings ratio.
Calculate an unlevered price-to-book ratio using the
residual operating income model.
Calculate an unlevered P/E ratio using the abnormal
operating income growth model.
