12 Business and Securities Valuation Flashcards
What is the dividend valuation model
The model states that a company’s value is the present value of all the future cash flows to investors discounted at the investors’ required rate of return for that company.
Constant Growth Model:
P0 = market value excluding any dividend currently payable
D0(1+g) = expected dividend in one year’s time (D1)
ke = shareholders required rate of return
P0 = (d0x(1+g))/ (ke-g)
If the dividend isn’t going to grow constantly - ie it will grow for three years and then stay the same, you can simply grow the dividend each year discounting at the cost of capital (like an NPV)
What is the dividend yield
Dividend yield is what you are getting for your shares.
It is calculated as:
dividend per share / market price per share x 100%
Therefore market price per share is
dividend per share / dividend yield x 100%
What is the PE ratio and what is it for?
The PE ratio is a very useful yardstick for assessing the relative worth of a share. The P/E ratio is calculated as:
P/E = market price per share / earnings per share
or
Total market value of equity / total earnings
Therefore market value of equity = P/E ratio x earnings (being PAT - preference dividends)
REMEMBER: if you have borrowed a PE ratio you need to discount for the fact that your shares are unquoted (say 25%)
Income - EBITDA / enterprise value model
What is it?
The EBITDA or Enterprise value model is seen as an alternative to the PE model.
The main difference is that the EBITDA model removes some subjective factors such as depreciation and amortisation and some non controllable factors such as tax and interest.
Enterprise value = MV equity + MV debt + MV prefs + MV Non controlling interests - Cash
EBITDA = EBIT + depreciation + amortisation
Enterprise Value Multiple = Enterprise value / EBITDA
(often taken from a proxy listed company)
To value the equity of the company therefore:
Equity = (EVM x EBITDA) - MV debt - MV prefs - MV NICs + Cash
What is the Enterprise Value
What is the Equity Value
The value of a company that is available to all of its debt and equity holders
The portion of the enterprise value that is available to just equity holders
Think of it this way - you have future cashflows - those don’t all belong to the shareholders. Some of it belongs to the debt-holders.
Discounted Earnings - what is it and how does it work
A company’s equity can be valued by discounting all of its future earnings at the cost of equity.
This is an approximation to free cashflows valuation method but technically inferior since it is possible to manipulate profits using accounting policies.
Put in all your earnings down to profit after tax and then discount it. Simples.
Asset based models
Net asset method - what is it how does it work
The value of a share in a particular class is equal to the net tangible assets attributable to that class divided by the number of shares in that class.
This method fails to take account of the value of intangible assets which have not been capitalised by the target company.
Value based models - what are they
Value is created only when companies invest capital at returns that exceed the cost of that capital.
Value based models focus on how companies use the idea of value creation to make both major strategic and every day operating decisions.
Value based model = Free cash flow model
Free Cash Flow Model
Method 1: Use if you know WACC
Step 1:
- EBIT
- less tax (eg 76% of above figure
- Gives you operating income after tax
- Add back non cash charges (depreciation)
Less - capital expenditure
Less - increases to working capital (or plus decreases)
Free cashflow
Step 2:
- Forecast the terminal value - for a time horizon of six years (or perpetuity)
Step 3
- calculate the WACC using ke and kd (though why you would use this method if you didn’t know the WACC I don’t know. I guess if you didn’t know interest.
Step 4
- discount the cash flow at WACC to obtain value of the firm
Step 5
- calculate equity value = value of the firm - value of debt + value of investments
Method 2: use if you know ke & interest
- EBIT
- less interest
- less tax
Add back: non cash charges
Less: Capex
Less: Net workign capital increases
Plus: Net working capital decreases
Plus: Salvage values received.
Step 2: forecast terminal value over 6 years (or perp?)
Step 3: discount cash flow at ke
Done
Economic Value Added
This is residual income but trademarked
Put most simply it is net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise.
It is calculated as:
Net operating profit after tax
Less capital charge
(WACC x net assets at start of year)
= EVA
Summary of EVA Adjustments:
Profit figure needs to be pre-interest since ke is included in finance charge via the WACC
Start with operating profit and deduct cash taxes (tax charge per financial statements PLUS the cash saving on interest since the tax charge will no longer benefit from the interest cost)
Alternatively start with PAT and add back interest net of tax to give the same result
Training costs, R&D, advertising - add these back to the profit if they have been deducted. These costs should be capitalised in the year in which they occurred.
Depreciation - add back accounting depreciation and deduct economic depreciation as a better guide to the true fall in value of assets. Also adjust the capital employed for net difference between accounting and economic depreciation unless the assets are already shown at replacement cost. Be careful to read the question carefully on this point.
Provisions (eg doubtful debt, deferred tax and inventory) - any movements in these provisions that have been recognised in the income statement should be removed from the NOPAT calc.
Other non cash items - add back non cash expenses to profit and also add them to capital employed.
Adjusted present value
Hasn’t come up yet
Under the APV method cash flows of the company are discounted using the ungeared cost of equity (keu). This is added to the present value of the tax shield discounted at the pre-tax cost of debt. There’s an example. You can also see how to convert geared beta to asset beta.
Valuing majority shareholdings - why do it and what discounts to use
The valuation of a majority shareholding must reflect the extent to which a potential buyer of the shares can or cannot control or influence the company.
Unless there are exceptional circumstances, if the degree of control is less than complete the value of the shares will be less than a pro-rata proportion of the overall value of the company.
Shareholding 75% + - nil to 5%
>50% but <75% - 10 - 15%
50% 20-30% (but a much greater discount if another party also holds 50%)
High growth start-ups - challenges for valuation
Most start ups typically have no track record
Ongoing losses
Few revenues, untested products
Unknown market acceptance, unknown product demand
Unknown competition
Unknown cost structures, unknown implementation timing
High development or infrastructure costs
Inexperienced management
overall a lot of uncertainty
Possible sources of synergies
- economies of scale (bulk buy discounts, redundancies, buildings)
- complementary resources
- increased market power
- financial synergy (due to diversification of risk) (reduces WACC)
- lower cost loans (reduces WACC)
Valuation of debt - irredeemable debt
Po = i/rd
rd is the pre-tax cost of debt
P0 = (i(1-T))/kd
