Valuing Intrsinsic value using RI model

CFA Level II Equities
#1

Hi all
I am quite confused with the Terminal value in RI model in calculating the intrinsic value of the equity, because sometimes its just the last RI (for example in the case where we have a persistence factor when the ROE will slighlty converge to r) and in other cases it is the excess of the given terminal market price over the terminal BVPS and that excess has to be discounted.
Can someone elaborate pls?

#2

Hi,
both things are the same as discounting the last RI will be equivalent to the surplus of the TV over the BV.

Oscar

#3

well, Im affraid its not, but look at the following example:

  • Book value per share is estimated at $9.62 on 31 December 2007.
  • EPS will be 22 percent of the beginning book value per share for the next eight years.
  • Cash dividends paid will be 30 percent of EPS.
  • At the end of the eight-year period, the market price per share will be three times
    the book value per share.
  • The beta for UPS is 0.60, the risk-free rate is 5.00 percent, and the equity risk premium is 5.50 percent.
    So, apart from discounting the RI8 which is part of the PV of future RIs, you have a Teminal value whish is the difference between Market price at end of period 8 and the BVPS8.
#4

Actually, I`ve found the explanation in the books and it relates to how long is the forecasted period. In case of longer forecasted period the RIs tends to become zero and the ROE especilally in a competitive environment tends to equal the required rate of return on equity, ie. ROE=r. But for shorter forecasted time horizon, a forecast of premium over the BVPS at the end of the forecast horizon should be calculated.

#5

If the share is valued at its fair value (=market price) both will lead to the same present value. Only if there is an over-/undervaluation there will be a mismatch.
Regards,
Oscar