[MUSIC PLAYING] Welcome back. This is Dr. Bob Nolley. Let's wrap up our discussion of value and valuation with some comments about how we figure out what a company is worth.
There are several approaches to be used in business valuation-- the income approach, the asset-based approach, and the market approach. Among the income approaches is calculating the Weighted Average Cost of Capital, or the WACC. It is the weighted average cost of capital and the average cost of a unit of income for the company.
We calculate this by using a weighted average of the cost of bonds, the after-tax yield of maturity, and the required return on common stock, and preferred stock, if there is any.
The income approach also includes the Capital Asset Pricing Model, or the CAPM. This expresses a required return on a company as a function of risk and a comparison of how risky the stock is compared to the risk of the market as a whole.
There is also a method based on assets to determine the value of a business. The cost for estimating what it would cost to buy the total assets of the business with the same economic utility, but would do the same thing, is the asset-based approach.
The truest way is the market approach. This tells us the true value of the firm. It is what the market says it is. It's the current price of a share of common stock times the number of shares outstanding.
The shares of common stock represent ownership. And in the market, price represents the true value of what each of those shares are worth.
Now let's review. We have the weighted average cost of capital, which is the average after-tax cost of bonds and the required return of common stock. We can use the CAPM, the Capital Asset Pricing Model, which is based on risk, the risk of the company compared to the risk for the market overall.
There's the asset replacement approach, which estimates the cost of replacing all the assets of the company with those of the same utility.
And then finally, market value, which probably represents the true value. It's what the market says the shares of common stock ownership are worth.
This is Dr. Bob Nolley. And I'll see you in the next lesson.