To compute the terminal value, we use the stable-period
reinvestment rate and cost of capital estimated earlier:
Addingthepresentvalueoftheterminalvaluetothepresent
valueofcashflowsduringhighgrowthyieldsthevalueofthe
operating assets:
Adding the value ofcash and marketable securities ($940
million) and subtracting debt ($643 million) and options
($171 million) results in equity value of $6,556 million.
Dividingbythenumberofsharesoutstanding(1,330million)
yieldsavaluepershareof$4.93.Siriuswastradingat$7.27
in November 2005, making it significantly overvalued.
Advantages and Limitations of Cost of Capital Approach
Thebiggestadvantageofthecostofcapitalapproachisthatit
incorporates the costs and benefits of borrowing. It is
relatively simple, as we will see later in this chapter, to
examinehow firmvalue will changeas financial leverage
changes in the cost of capital approach.
Therearethreeproblemsthatweseewiththeapproachand
itsrelianceoncostofcapitalandfreecashflowstothefirm.
Thefirstisthatthefreecashflowstoequityareamuchmore
intuitivemeasureofcashflowsthancashflowstothefirm.