The net present value approach can be used to calculate the value of a
company's stock. I'd like to find some really good information on how
to determine the discount rate on the company's earnings, how to use
growth rates, how to define the earnings or cash flows, etc.

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Request for Question Clarification by livioflores-ga on 18 Mar 2004 07:01 PST

Hi gt3!!

I am working in this question and need to clarify some points:

I am not sure if you are looking theoretical information like
formulas, definitions,etc. or if you are looking for something more
practical.
To know how will you use this information is a good way to give you
the proper tools.

Thank you.
livioflores-ga

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Clarification of Question by gt3-ga on 18 Mar 2004 07:09 PST

Hi livioflores,

I'm looking for how to use NPV to calculate stock prices that I am
considering as possible investments. So knowing what to plug into the
equations is very important. For example, do I use the interest rate
on ten-year treasuries or do I use some risk adjusted return or what?
Also, just what am I discounting? Cash flows, EPS, etc.

This is suprisingly difficult to find. You can get the theory and the
formulas in Business Finance. But I don't remember learning how to
apply this to the real world.

Thanks.
GT3

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Request for Question Clarification by livioflores-ga on 18 Mar 2004 20:16 PST

Is this the kind of info that are you searching?:
"STOCK VALUATION":
http://www.bus.indiana.edu/cholden/fall2002/Fc/Stocktwo.htm

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Request for Question Clarification by omnivorous-ga on 18 Mar 2004 21:23 PST

GT3 --

This is not an extremely difficult issue, though I must say that the
territory is strewn with debates over the "real" cost-of-capital.  And
it's complicated by studies that imply that "beta" or risk-adjusted
measures are irrelevant:
"Cross Section of Expected Stock Returns," (Omnivorous-GA, Nov. 8, 2003)
http://answers.google.com/answers/threadview?id=273817

Generally, corporations use a weighted-average cost of capital (WACC)
that uses bonded indebtedness and shareholder returns (with the stock
beta factored in) to determine a discount value for NPV:
QuickMBA
"Security Analysis"
http://www.quickmba.com/finance/securities/

But there are many debates over such issues as:
*  should market or historical borrowing be used?
*  what's the proper period for measuring a beta?
*  how is risk adjusted internally for different projects within the corporation?
*  should different businesses (divisions) receive different treatment?
*  how should instruments such as leases be factored into the analysis?

Net: is there anyone that would try to specify a cost-of-capital for a
firm?  Not that I'm aware of -- because it's already a subject of
great debate WITHIN the firm. . .

Best regards,

Omnivorous-GA

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Clarification of Question by gt3-ga on 19 Mar 2004 06:19 PST

I was looking for something on NPV with real world examples that I
could apply right away.

I haven't seen that in the answers so far so I may have to go with the
quickmba.com link provided in one of the comments. Warren Buffett
supposedly uses the long term risk free rate in his calculations. Now
that's easy.

GT3

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Clarification of Question by gt3-ga on 19 Mar 2004 10:42 PST

How do I close this question and pay omnivorous for the answer I used?
I don't see any place on my home screen to do this.

I'd also like to thank livioflores.

GT3

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Request for Question Clarification by omnivorous-ga on 19 Mar 2004 11:55 PST

GT3 --

If you'd like, I can submit the information above as an answer.  (I
want to thank you for raising an interesting issue regarding how
Warren Buffett sets up discount rates -- though he's probably one of
the few guys that could get away with borrowing at the 10-year T-bill
rate.)

Best regards,

Omnivorous-GA

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Clarification of Question by gt3-ga on 20 Mar 2004 07:23 PST

Omnivorous,

Yes, please post your answer and we'll wrap this up.

Thanks.

GT3

GT3 --

Finance education uses the WACC to determine corporate cost of capital
and the QuickMBA overview is a good, but not overly technical
discussion of the topic:
QuickMBA
"Security Analysis"
http://www.quickmba.com/finance/securities/

Having been trained in finance and having worked for large and small
corporations, the debates that I mentioned above occur continually. 
If corporate management allows it, divisions of companies in different
businesses (and different risk profiles) can make the debate lively.

However, I hadn't read any of Warren Buffett's writing, so I did a
little research and found this interesting summary of Buffet:
Amazon.com
"So You'd Like to Invest Like Warren Buffett" (Hupalo, undated)
http://www.amazon.com/exec/obidos/tg/guides/guide-display/-/80RZHTAQ4RMT/002-4934179-5017627

Buffett's work, like that of skilled investment bankers, goes into
assuring that he arrives at a guaranteed cash flow.  Having been
involved in high tech businesses, I can say that strategy is one solid
way to avoid risk -- as cash flow estimation in
electronic/Internet/software products markets during the 1980-2004
timeframe has been highly variable.  This, of course, explains
Buffett's avoidance of many technology firms and the Internet boom of
the last half of the 1990s.

A Google search strategy using the first set of terms will lead to
lots of discussion of the practical application of NPV:
"cost of capital" + "discount rate"
And how one leading investor uses it can be found this way:
"Warren Buffett" + "discount rate"

Best regards,

Omnivorous-GA