Whilealloftheequationsarebasedonatwo-stagedividend
discountmodel,theycanbegeneralizedtotheFCFEmodel
byreplacingthepayoutratiowiththeratioofFCFEtonet
income. Therearetwoadvantages to thissubstitution. The
firstisthatwegetmorerealisticestimatesofthemultiplesfor
companiesthatarenotpayingouttheirFCFEasdividends.
The second is that that the FCFE/net income or potential
payoutratioisnotconstrainedtobegreaterthanzero.Inother
words, if the FCFEis negativebecause thefirm reinvests
morethanits netincome,thepotentialpayoutratiocanbe
negative at least for the high-growth phase. A negative
potentialpayoutratioindicatesthatthefirmwillhavetoraise
new equity during its high-growth phase to fund its
reinvestment, and this expected dilution willpush theP/E
ratio down today.
ILLUSTRATION 8.1: Estimating Equity Multiples for a
High-Growth Firm in the Two-Stage Model
Assumethatweareestimatingequitymultiplesforafirmthat
had the following characteristics:
- The firm reported net income of $15 million on
revenues of $150 million last year and equity
investedof$75million.Theresultingnetmarginand
return on equity are shown here.