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Since long-term debt holders have a priority claim and common stockholders have a residual claim,
to determine Hudson‟s value of common equity you must subtract the debt holders‟ current claim on
the firm, or $176,978,000, from total firm value: $476,909,000 minus $176,978,000 equals
$299,931,000, which is the value of Hudson‟s common equity.
The final step in determining the value of one share of Hudson‟s stock is to divide this value of
common equity by the number of shares of common stock that Hudson has outstanding, so if Hudson
has five million common shares outstanding, its stock value is $299,931,000 divided by 5,000,000, or
$59.99 per share.
We have just discussed and illustrated the discounted cash flow (DCF) method of equity valuation.
This method, and the valuation template included in the chapter materials, can be used to determine
the value of any firm, with one modification. This modification is that terminal value cannot be
calculated until the firm slows to a constant and perpetual growth rate. In the Hudson Hybrid Car
Company example, this occurred in 2013, so four years (2009, 2010, 2011, and 2012) had to be
individually forecast before using the terminal value formula. If a company is not expected to slow to
a constant and perpetual growth rate until 2015, then two more years must be individually forecast
before applying terminal value. If a company is already in a mature state and growing at a constant
and perpetual rate, then terminal value can be applied immediately and there is no need to forecast any
years individually.
It is also possible to calculate the value of equity for a company using the relative value method.
This method is easier to use, as it involves taking some performance measure of a company and
applying the price to performance measure from a comparable company. Continuing with the Hudson
example, recall from Exhibit 5.10 that Hudson had net income of $64,716,000 in 2008. This was
Hudson‟s sales revenues minus all expenses, including operating expenses, interest expenses paid to
debt holders, and income tax expenses paid to governmental authorities, so it represents net income
available to Hudson‟s common stockholders. Assume there is a publicly traded company, the Gracie
Green Transit Company, which is comparable to Hudson. If Gracie‟s net income in 2008 was
$221,976,000 and its total value of equity was $1,420,646,000, then Gracie‟s price-to-earnings ratio
was $1,420,646,000 divided by $221,976,000, or 6.40 times earnings. If Hudson is a true and perfect