The intrinsic valuation methods used to value Apache Oil Corporation were the discount dividend model, the free cash flows model, the residual income model, and the long run residual income model. These models are superior to the method of
comparables models because they examine many different angles of the company. Using these models, it is easier to get an overall view of Apache Oil.
Discount Dividends Model
Shareholders receive value of a firm through dividends. The discount dividends model shows the value of the future dividends, which is also how shareholders
determine the amount of value they will receive from the firm. The model forecasts out future dividends and discounts them back to the present. If the value given by the discount dividends model is higher than the current stock price, then the company’s stock is undervalued.
The discount dividends model is only as reliable as the assumptions used. The model requires assumed discount prices, as well as growth rates. In reality, it is not likely that a company’s dividends will grow at a constant growth rate indefinitely. For this reason, this model cannot be extremely dependable.
Sensitivity Analysis Growth 0 0.02 0.04 0.06 0.08 0.09 0.1 $11.06 $12.45 $14.76 $19.39 $33.27 $61.02 0.12 $8.99 $9.78 $10.95 $12.92 $16.84 $20.76 ke 0.14 $7.55 $ 8.02 $8.69 $9.69 $11.36 $12.69 0.157 $6.62 $6.95 $7.39 $8.00 $8.94 $9.61 0.18 $5.67 $5.88 $6.14 $6.48 $6.97 $7.29 0.2 $5.04 $5.18 $5.35 $5.57 $5.87 $6.06 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15%
To begin valuing Apache Oil Corporation using the discount dividends model, the first step was to forecast out the dividend prices. There was a consistent growth rate of 25% in the dividend prices through 2002 to 2006. Although the growth rate was constant, we decided that a 25% growth rate over the next 10 years would be too large. Instead, we grew the dividend price at $.08 per year. This growth seemed to be more realistic and could provide us with the most reliable valuations. We then
discounted the dividends back to the present value and found the sum of these. We then used the perpetuity equation to value the firm from beyond the forecasted out 10 years. To determine the final value of the company, we added the value of the firm for the next 10 years with the value of the perpetuity.
The results from the discount dividends model show that Apache Oil is largely undervalued. This means that there is a very small amount of dividends that are being paid out to shareholders, which is not beneficial for them. The reliability of this model could have been compromised by our assumptions, but there is no way of knowing this. In order for Apache’s stock to be fairly valued, the cost of equity would need to be
Free Cash Flows Model
To create the free cash flows model, the first step was to calculate the annual free cash flows. This was done by the cash flows from investing activates from cash flows from operating activities. We then calculated the present value factor. This was used in calculating the present value of the annual free cash flows by multiplying the present value factor by the annual free cash flow. We added all of these together to get the total present value of annual free cash flows. The continuing terminal value perpetuity was then computed by dividing year 10’s cash flow from investing activities by the initial before tax WACC minus the growth rate. This number was multiplied by year 10’s present value factor to get the present value of terminal value perpetuity. The value of the firm was then computed by adding together the total present value of total free cash flows and the the present value of terminal value perpetuity. The
estimated market value of equity was then computed by the book value of liabilities from the value of the firm. The estimated price per share was the calculated by dividing the estimated market value of equity by the number of shares outstanding. Finally, the time consistent implied price, which are the numbers that are included in the sensitivity analysis, are computed by multiplying the estimated price per share by one plus the initial before tax WACC and taking that forward 2 months.
Sensitivity Analysis Growth 0 0.02 0.03 0.04 0.045 0.05 $ 7.64 $ (178.89) $ (412.05) $ (1,111.55) $ (2,510.53) 0.06 $ 62.23 $ (43.81) $ (149.85) $ (361.93) $ (574.00) WACC 0.07 $ 96.56 $ 30.36 $ (27.56) $ (124.09) $ (201.32) 0.0852 $ 126.84 $ 90.62 $ 62.67 $ 22.35 $ (5.33) 0.09 $ 132.91 $ 102.35 $ 79.43 $ 47.34 $ 25.95 0.1 $ 141.96 $ 119.99 $ 104.30 $ 83.38 $ 70.17 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
Our sensitivity analysis shows that Apache’s stock is overvalued. This model has the most fairly valued share prices out of all the sensitivity analyses computed. This model also has the most undervalued share prices in comparison to the others. Despite this, the sensitivity analysis shows that Apache’s stock price is largely overvalued.
Residual Income Model
The residual income model is the most reliable of the intrinsic valuation methods. This is because the overall value of the firm includes a high percentage of the present value of residual income. This number is based off of the forecasted out earnings of the firm, which is why this model is the most accurate.
Sensitivity Analysis Growth 0 -0.05 -0.1 -0.15 -0.2 -0.25 0.1 $ 26.15 $ 29.08 $ 30.55 $ 31.43 $ 32.02 $ 32.44 0.12 $ 31.68 $ 33.18 $ 34.00 $ 34.52 $ 34.87 $ 35.13 ke 0.14 $ 35.39 $ 36.19 $ 36.66 $ 36.97 $ 37.19 $ 37.35 0.157 $ 37.72 $ 38.21 $ 38.51 $ 38.71 $ 38.86 $ 38.97 0.18 $ 40.18 $ 40.44 $ 40.61 $ 40.72 $ 40.81 $ 40.87 0.2 $ 41.91 $ 42.06 $ 42.16 $ 42.23 $ 42.29 $ 42.33 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
To derive the numbers used in the residual income model, earnings had to be forecasted out. The difference between the operating cash flows and investing cash flows are the actual earnings. We then determined the benchmark earnings, which is the previous year’s earnings multiplied by the cost of equity. The residual income is the difference between the actual earnings and the benchmark earnings.
Our sensitivity analysis determined that, once again, Apache’s stock is highly overvalued. In order to make our stock price fairly valued, Apache would need to greatly decrease their cost of equity, or highly increase their growth rate. Both of these options are unrealistic and would be impossible for the firm to follow through with.
Residual income, which is the added or destroyed value of the firm, is the main component in the residual income model. After the residual income was computed for each year, it was then brought back to the present by multiplying each year’s residual income by the present value factor. This number demonstrates whether the company is adding or taking away value from the firm.
0 1 2 3 4 5 6 7 8 9 10 11
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
PV of Annual Residual
As a company continues to grow, their residual income will eventually decrease until it declines to or past zero. Every company’s residual income will join with the market. Apache’s residual income goes negative on the fourth forecasted year. It is difficult to be sure that this number is correct because of the assumptions that had to be made about forecasted earnings.
Abnormal Earnings Growth Model
The first step in creating the abnormal earnings growth model is to find the company’s earnings and dividends. These are used in computing the Drip income, which is dividends paid multiplied by the cost of equity. We then determined
cumulative earnings, which is calculated by adding the earnings of the company to the drip earnings for each year. Normal earnings are then computed by multiplying each year’s earnings by the cost of equity. Abnormal earnings growth is finally determined by subtracting the normal earnings from the cumulative dividend earnings. These values were then brought back to the present by multiplying them by the present value factor. These were all added together to get the total present value of abnormal
earnings, which we calculated to be 1,308,635.15.
We then computed a continuing terminal value, which was the forecasted abnormal earnings growth for year 11, divided by Apache’s cost of equity minus the growth rate. The continuing terminal value was then multiplied by the forecasted year 10’s present value factor to determine the present value of the terminal value. The core earnings per share, which equals year zero’s earnings, was added to the present value of the AEG to determine the total average earnings per share perpetuity in time 1. We finally computed the intrinsic value per share, which is the total average
earnings per share perpetuity in time one divided by the cost of equity. Finally, the numbers in our sensitivity analysis were computed by multiplying the intrinsic value per share by one plus the cost of equity and then bringing this number forward 2 months.
The numbers included in the sensitivity analysis were determined by changing the cost of equity and the growth rate.
Growth 0 -0.05 -0.1 -0.15 -0.2 -0.25 0.1 $ 22.24 $ 28.40 $ 31.48 $ 33.33 34.56 35.44 0.12 $ 21.42 $ 25.25 $ 27.34 $ 28.65 29.56 30.22 ke 0.14 $ 20.25 $ 22.81 $ 24.30 $ 25.27 25.96 26.48 0.157 $ 19.23 $ 21.12 $ 22.27 $ 23.05 23.61 24.03 0.18 $ 17.94 $ 19.25 $ 20.10 $ 20.68 21.12 21.45 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
After the numbers in the sensitivity analysis were computed, the results showed that, again, Apache’s stock price is highly overvalued. The numbers were significantly below the November 1st, 2006 stock price of $99.18.
The AEG model and residual income model are linked. The change in residual income from year to year is equal to the abnormal earnings growth computed.
This chart shows the consistency between the annual AEG and the change in residual income per year. Because of this link, the share prices determined in the residual income model and the abnormal earnings growth model should be similar. The
greatest difference in the share prices determined in both models is at most $20, and at the least, less than $1. The reason for the difference in these share prices is because the present value of the perpetuities is different in each model. The differences in the share prices will lessen as the perpetuity grows towards infinity, and because a portion
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Annual AEG $ (446,501) $ (188,528) $ (199,497) $ (211,525) $ (224,686) $ (239,060) $ (254,728) $ (321,791) $ (232,478) $ (311,459) Change in RI $ (188,528) $ (199,497) $ (211,525) $ (224,686) $ (239,060) $ (254,728) $ (321,786) $ (232,478) $ (311,459)
of the share prices are only off by less than $1, this shows that both models are closely linked.
Long Run Residual Income Model
The long run residual income model is also a reliable model because it links the cost of equity, long run return on equity, and the long run growth on equity.
The first sensitivity analysis is determined by holding the cost of equity constant, and changing the return on equity and the growth rate on equity. The different stock prices are computed by multiplying the book value of equity by one plus the return on equity minus the cost of equity, divided by the cost of equity minus the growth.
Sensitivity Analysis Ke= 15.7% Growth 0.14 0.16 0.18 0.2 0.22 0.15 $ 23.46 $ 132.95 $ 52.02 $ 46.38 $ 44.32 ROE 0.17 $ 70.38 $(132.95) $ 17.34 $ 27.83 $ 31.65 0.19 $ 117.31 $(398.84) $ (17.34) $ 9.28 $ 18.99 0.21 $ 164.23 $(664.73) $ (52.02) $ (9.28) $ 6.33 0.23 $ 211.15 $(930.62) $ (86.70) $ (27.83) $ (6.33) Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
The next sensitivity analysis was determined holding the growth rate of equity constant and changing the cost of equity and the return on equity.
Sensitivity Analysis Growth= 17.77% Ke 0.12 0.14 0.16 0.18 0.2 0.15 $ 19.13 $ 29.29 $ 62.48 $(469.27) $ (49.34) ROE 0.17 $ 5.29 $ 8.10 $ 17.29 $(129.83) $ (13.65) 0.19 $ (8.54) $ (13.08) $ (27.91) $ 209.60 $ 22.04 0.21 $ (22.38) $ (34.27) $ (73.10) $ 549.04 $ 57.73 0.23 $ (36.22) $ (55.46) $ (118.30) $ 888.48 $ 93.42 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
The last sensitivity analysis was computed holding the return on equity constant, while changing the growth of equity and the cost of capital.
Sensitivity Analysis ROE= 18.6% Growth 0.13 0.15 0.17 0.19 0.21 0.12 $(223.43) $ (47.89) $ (12.78) $ 2.27 $ 10.63 Ke 0.14 $ 223.43 $(143.66) $ (21.30) $ 3.17 $ 13.66 0.16 $ 74.48 $ 143.66 $ (63.89) $ 5.29 $ 19.13 0.18 $ 44.69 $ 47.89 $ 63.89 $ 15.87 $ 31.88 0.2 $ 31.92 $ 28.73 $ 21.30 $ (15.87) $ 95.64 Overvalued > 114.06 Undervalued < 84.30 Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
To calculate the return on equity, we averaged the return on equity from the past 5 years. We then calculated the growth of equity, which we calculated by
averaging the growth of the book value of equity from the past 5 years also.
These three sensitivity analyses also show that Apache’s stock is overvalued.