An investor wants to determine the intrinsic value of the common stock for a company with the following characteristics:
·The firm maintains a constant dividend payout ratio
·Goodwill and patents account for 40% of the firm's assets
·The firm's revenues and earnings are highly correlated with the business cycle
Further, the investor focuses on the firm's capacity to pay dividends rather than expected dividends. Considering the above, the investor will most likely use which of the following valuation models?
Free-cash-flow-to-equity (FCFE) is a measure of the firm's dividend-paying capacity which should be reflected in the cash flow estimates rather than expected dividends. Analysts must make projections of financials to forecast future FCFE and thus the constant growth assumption as in the Gordon growth model is not an issue. An asset-based valuation model is not appropriate considering the high proportion of intangibles (goodwill and patents) in the firm's assets.