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Technology Stocks : Dell Technologies Inc. -- Ignore unavailable to you. Want to Upgrade?

To: Chuzzlewit who wrote (30511)	2/19/1998 11:38:00 PM
From: Reginald Middleton	Read Replies (1) \| Respond to of 176387

<and among the problems that I see in your approach is that (a) there is no measurement of the average weighted cost of capital - there is simply a range of kw's> I'm not sure I understand when you say there is no measurement of the WACC, please explain. As I explained it, each major contributor to the capital base is given an appropriate cost, in the case of equity y = risk free rate +(Equtiy Risk Index * Market risk premium). In the case of debt and debt like instruments - the tax shield, and risk premium to the risk free rate are taken into consideration. Afterwards, all contribution to the total cost is calculated via a capitalization weighted average. I see no assumption here. <These are undoubtedly incorrect because the whole assumption of perpetual growth is incorrect (that is, you created it as a surrogate for an unknown stream of cash flows). So what you are trying to do is collapse this unknown stream of free cash flows into an equivalent stream assuming perpetual growth. Clearly, this cannot be done in the absence of a meaningful discount rate (which is measured, not assumed) and in the absence of an explicated free cash flow stream.> I see your reasoning here about perpetual growth (not necessarily agree with it though), but you also state that the assumption of a terminal value is useless as well. This leaves no method (to be honest, I was testing the model and arbitrarily put the perpetual growth in, but I still do not belive this produces a grossly inaccurate measure). Furthermore, I allege that the cost of capital is a meaningful discount rate for it appropriately adjusts the risk free rate to the market's expected return of the entity in question (assuming you believe in CAPM). <Suppose a corporation's sole source of income is a bond paying 6%. Now, the corporation could dividend the entire interest payment to its shareholders or it could buy additional bonds at 6%. If it opts for the former there will be no growth in cash flow to the corporation but there will be a steady stream of dividends to the s/h's. In the latter case, the company's cash flows will increase at 6% per annum but there will be no dividends to the s/h's. BUT, the company has the same value in either case.> Let's put this to the test. It doesn't account for the increased value of the corporation in reinvesting the 6% in the purchase of the additional bond (or more realistically, the tax shield may not be significant for a company that invests non-op income in bonds, but consider the investment of non-op income in a tax shielded investment such as R&D or marketing, which are used heavily by growth companies). For one, total cash flows will be reduced through taxation by the dividend to the shareholders. This being true, the reinvestment of the cash flow holds greater value for the investor and the corporation (all other things remaining the same). This invalidates the dividend theory. Second, the issue of efficiency and reinvestment risk comes into play in releasing cash flows to investors. This is especially so in hypergrowth companies and high growth industries. For instance, it is highly unlikely that the individual investor could have matched the performance of Dell, MSFT, or INTC (all hypergrowth companies whose rate of capital growth is greater than their cost of capital) in a portfolio of investments over any reasonable horizon. This being so, the cash generated by the companies in question have greater value in the hands of management than they do in the form of a shareholder dividend, therefore the company that reinvested the cash would be worth more as an investment than the company that provided it as s/h dividend. Think of the difference in the value of MSFT if it issued dividends in lieu using that cash in Win 95 development of Win NT 4.0 developement. If this is true, it would invalidate the the validity of the dividend theory as well. Now I can agree that I may have taken a short cut with the per growth rates (but again this would not have created a gross error), but there are weaknesses in the perpetual growth model as you have stated. If I were to use a muliple of EBITDA or EBIT, your assumptions would still invalidate the valuation due to the fact that the weighted average cost of capital is not a valid discounting rate, which I definitely disagree with. In order to assist me in coming around to your way of thinking, how would you suggest producing a risk adjusted discounting rate?