A business valuation of a company, especially one the size of Target, is a mystery but is often an integral part of planning, decision-making, strategic assessment, and maybe an equitable resolution to a touchy concern. Knowing what a business is worth and placing a value on it builds confidence so undervalue or overvalue of the business does not happen. Team C will perform a capital valuation of the retail merchandising chain Target.
To obtain the answers needed for the valuation, Team C will justify the current market of Target’s debt and equity by using various capital models of valuation. Team C will provide in-depth calculation of the discoveries and include models with rates of return. Current Market Price of Target’s Debt Valuation models are used in investment decisions whether it is a decision on which assets are under or overvalued. When in an efficient market, the market price is the best estimate of value. The purpose of the Discounted Cash Flow valuation model is the justification of the value.
In the discounted cash flow valuation, the value of an asset is the present value of the expected cash flows on the asset. The information needed to use the discount cash flow valuation is: estimate of the life of the asset, estimate the cash flows during the life of the asset, and estimate the discount rate applied to these cash flows to obtain a present value (Damodaran, n. d. ). In the Cash Flow valuation, the cash flow in period is t, r is the discount rate appropriate given the riskiness of the cash flow, and t is the life of the asset.
Target can have two propositions. Proposition 1: is for an asset to have value, the expected cash flows has to be positive over the life of the asset. Proposition 2: the assets generate cash flows early in life will be worth more than assets that generate cash flows later (Damodaran, n. d. ). Therefore, the current market price of Targets outstanding debt is difficult to obtain directly because debt is in the form of bonds, outstanding market trades, etc.
Many firms have non traded debt, which is specified in book value and not in market value terms much of this information is not publicly provided. Current Market Price of Target’s Equity Many of the ratios used to evaluate a company can be used to evaluate and justify the current market price of Target’s equity. One valuation model, which is good for evaluating Target’s equity, would be the price per earnings (P/E) ratio, which gauges the quantity in which investors are prepared to give for every dollar of a business’s earnings.
An elevated P/E ratio indicates larger investor assurance in the company. The P/E ratio is figured by dividing the market price per share of common stock by earnings per share (Gitman, 2006). Gitman explains “The P/E ratio is most informative when applied in cross-sectional analysis using an industry average P/E ratio or the P/E ratio of a benchmark firm” (p. 70). Targets industry is categorized as discount variety stores, and includes 12 other companies (YCharts, 2010).
Although the P/E ratio is good for comparing a company with other companies in the industry, the main valuation model for evaluation the value of common stock is the basic common stock valuation model, which seeks to determine “the value of a share of common stock is equal to the present value of all future cash flows (dividends) which is expected to provide over an infinite time horizon” (Gitman, 2006, p. 342). The variables in the basic common stock valuation model are worth of the common stock, per share dividend accepted at the end of a specified year, and obligatory return on common stock (Gitman, 2006).
Sometimes a firm has no history of paying dividends, so the basic common stock valuation model will not work. In this case, the free cash flow valuation model can be used to approximate a firm’s value based on free cash flows (FCFs). Gitman (2006) explains the free cash flow model is built on the similar idea as the basic common stock valuation model; however as an alternative of using a firm’s dividends, the valuation model uses the firms estimated FCFs.
The variables in the free cash flow valuation model are value of the whole business, free cash flow anticipated at the end of a specified year, and the business’s average weighted cost of capital (Gitman, 2006). Rate of Return Calculations In general, ROI can be calculated once the following is known: 1. The starting investment value (C0) 2. The ending investment value (C1) The general formula is: [pic] ROI gives a speedy assessment of investment performance, and it assists that ROI can be computed mentally.
Rate of Return is a more complicated return measure and is widely used in the finance world for valuations. Internal Rate of Return is the annualized complex rate, which can be earned on invested money, also known as the yield. Internal Rate of Return consists of investment growth but unlike ROI it also accounts for the timing of the cash flows. Team C has calculated the Target, selected financial data through the source based on data from Target. Annual Reports. Target’s Return on Investment has worsened from 2008 to 2009 but has gotten better slightly from 2009 to 2010. Selected Financial Data |30-Jan-10 |31-Jan-09 | |Revenues |65,357 |64,948 | |Stockholders’ Equity Attributable to |15,347 |13,712 | |Parent | | | |Total Assets |44,533 |44,106 | | | | | | | | | |Return on Investment |30-Jan-10 |31-Jan-09 | |Return on Equity (ROE) (%) |16. 1 |16. 15 | |Return on Assets (ROA) (%) |5. 59 |5. 02 | | | | | Defense of Valuation Model The use of valuation models is a very useful tool for organizations to use. However, it is important that companies choose the best valuation model when choosing to calculate their numbers. Companies must first assess what information they are seeking out and then determine which valuation model will provide the most accurate assessment of this information. In Target’s case, there are various models to choose from.
The most appealing for the company, however, is the Free Cash Flow Valuation Model. Various reason this model meets Target’s needs better than the other possible models. First, it is based upon the company’s free cash flows, which are easier to calculate than future dividends (Gitman, 2009). The Basic Common Stock Valuation Model relies heavily on dividends, which can be quite difficult to forecast. Because of this, the basic model does not work for Target. Target will benefit more from the free cash flow model because it offers the same information in a more accurate way.
The free cash flow model is an extremely helpful tool for large public companies looking to determine the value of a certain operating unit or division of the company (Gitman, 2009). The free cash flow model uses calculations similar to those models based on dividends. In this model, the company’s future free cash flows are calculated. This number represents how much money remains after all debts have been paid (Gitman, 2009). Using this model allows the firm’s owners to determine the value of the company in an accurate, reliable way.
Because cash flows are somewhat easier to determine and forecast, this model is appealing to firms looking for an accurate valuation number. Companies using models based on dividends, such as the basic common stock model, risk the chance of inaccurate numbers because of the lack of ability to forecast dividends properly (Gitman, 2009). For these reasons, the free cash flow model is the best model for Target to use when trying to value themselves. Conclusion For the foreseeable future, capital valuations of Target will feature merely humbly in the distribution and realization of earnings.
Targets shareholders will have to continue the managing team’s incentive for profitability and growth. Target must keep to a long-term view and reject uninformed step-ups in valuations. Target ought to prepare for future finance endeavors as they engaged in currently and ensure there is sufficient rationalization for a step-up in valuation if objectives are realized. Valuation can render a solid venture with increase attractiveness, but a valuation cannot recover a bad one. A business will typically obtain numerous finance options before an exit strategy must be is recognized.
Creating worth is the common aim of management and investors. A shared perception involving management and investors of reward and risks compelling a valuation is critical to opening a relationship on the same level.
References Damodaran, A. (n. d. ). Valuation. NYU. Retrieved from http://pages. stern. nyu. edu/~adamodar/pdfiles/country/Portugal. pdf Gitman, L. (2006). Principles of managerial finance (11th ed. ). New York, NY: Pearson, Addison Wesley. YCharts. (2010). Target. Retrieved from http://ycharts. com/companies/TGT ———————– [pic]