welcome

back we

did the comparable analysis

we got

Ra of

6.3 percent matched by a beta asset of .86

6 percent matched by .8 depending on which valuation method is more appropriate

for the tax shield we are now going to apply it to valuation I'm going to use

both approaches

throughout but at the end of the day based on information you have you’ll use

one approach

because there's no point actually there is some point in using all approaches

and trying to figure out what's going on

always you know if you set it up but at the end of the day you don't have to use

all three

in fact you may need information you may be able to do only one of them based on

what information you have

I always prefer adjusted present value though

okay so where did you get all this

Ra beta A information you got it from your comparable

so let's assume that the most important part is over

getting the comparable right getting beta asset and return on asset

right ok so now you want to do the valuation of the Sears idea

so let's give you some numbers for Sears what belongs to

Sears is the new online business

by what belongs I mean the cash flows are something that should have really

worried about and done

so let's assume for simplicity the cash flows are $250 million per year

for the foreseeable future what does that mean hint hint

you can do perpetuities simplicity

but by the way not too far from real life

because why not do a quick analysis to figure out how you're doing

and then more detail in life there are only four or five things in

every valuation there are discount rates cash flow estimates

growth rate in cash flows pretty much you're done to make calculations

simple sears is expected not to make capital investments

they've already made them working capital changes and depreciation are also

likely to be

close to zero this is not true in real life

just again to make things a little bit easier

now the first thing that Sears has to do

is to figure out whether it wants debt or not

and in order to do that it has to figure out

what is it focusing on so let's assume that Sears has thought through

this

and it wants its target debt to equity ratio to be 1

please write this but will leave this slide

up for a little while even while I'm talking

you are writing these notes so that this is basic information

but about whom not about bears anymore

not about the comparable but about your cash flows

and your financial policy so cash flows are 250 million per year

your financial policies are targeting a debt to equity ratio of 1

but when you go there you realize the debtto equity ratio means what 50 50

how much debt did the comparable have

30 out of 150 million only 20 percent

here it’s fifty percent so to make things a little bit realistic

the return on debt is 4 percent what was it before

2 percent for bears because they have lower debt

so making a little bit real because chances are the more debt you have the

riskier it is

for the debt holders as well there’s some chance of bankruptcy

and actually 50/50 is pretty high ratio so let's keep the

return on debt at 4 percent and remember that this is an example

now suppose the tax shield is

as the risky as Sears’ debt why am I saying

this because I want you to think about this because you can’t blindly run with

valuation

making some such assumption okay what does that mean

I'm signaling to you that if you want to use the tax shield

value of the tax shields of debt

for Sears not for bears that is done

you have to know use Rd as the discount rate simply because you've made that

assumption ok not Ra Rd so we are using approach one

using approach one let's do

all three methods so the first method we're going to talk about

and making sure my pen is working the first method we’ll talk about is

enterprise value method should be EBIT

I'm going to write this very slowly 1 minus TC

divided by

weighted average cost of capital

it's very important to have a symbol on weighted average cost of capital

because the weighted average cost of capital will be different

for bears and sears what will be same

Ra will be the same but the weighted average cost of capital will be

different why because weighted average cost of capital incorporates

the financial policy in the break you get

so this is so enterprise

valuation method is used a lot simply because it's simple

it looks simple but I think it's quite complicated because you're mixing

real and financial things

together quick question do I know the numerator

the answer is yes I know 250 million

times .66 so this is I'm going to use this number

over and over again so you might as well just calculate it

and see what it is okay but then

we don't know what WACC is

you have to figure out WACC so let's write the formula for WACC

and make sure we have

clear about what we know and what we don’t know

okay now I want Rd

and when I'm writing WACC I always pause and leave a gap so that

you know you're thinking instead of plugging and chugging
0:06:27.370,0:06:31.260
right so here have one minus