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CIMA - F3 > 8. Business Valuations > Flashcards

8. Business Valuations Flashcards

1
Q

What are the 5 reasons that a valuation may be necessary?

A
  1. Seeking stock market flotation
  2. Considering buying another business
  3. Looking to sell part of the business
  4. Valuation of potential borrower
  5. Tax purposes (e.g. passing on the business)
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2
Q

What are the 3 categories of methods for valuing equity?

A
  1. Asset based
  2. Earnings based
  3. Cash flow based
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3
Q

What are the 3 asset based methods of equity valuation?

A
  1. Historic cost
  2. Replacement cost
  3. Realisable value
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4
Q

What are the 2 earnings based methods of equity valuation?

A
  1. P/E ratio
  2. Earnings yield
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5
Q

What are the 3 cash flow based methods of equity valuation?

A
  1. Discounted cash flows
  2. Dividend yield
  3. Dividend growth model
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6
Q

What is the equation for market capitalisation?

A

Number of shares x share price

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7
Q

Although using different valuing methods, what is the equation for equity value using asset based methods?

A

Net assets -> Non-current assets + Net Current Assets - Long term liabilities
= Total assets - total liabilities

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8
Q

What is the pro of using book value in an asset based valuation?

A

Easy to determine

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9
Q

What is the con of using book value in an asset based valuation?

A

May be historic cost and not representative of current market values

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10
Q

What is the pro of using realisable value in an asset based valuation?

A

Give a better indication of price in a sell off or asset stripping situation

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11
Q

What is the con of using realisable value in an asset based valuation?

A

Realisable values need to be known, and may be lower than market values

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12
Q

What is the realisable net asset value often used for?

A

The minimum price a seller of a business may accept

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13
Q

What is the replacement cost net asset value often used for?

A

The maximum price a buyer might consider paying for a business

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14
Q

What are the 2 advantages of asset based valuations?

A
  1. Quick and simple to estimate
  2. Gives a good minimum/starting point
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15
Q

What are the 3 disadvantages of asset based valuations?

A
  1. Not as good at valuing ongoing earnings
  2. Does not consider values of intangible assets
  3. Reliant on accounting conventions
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16
Q

What is the equation for the P/E ratio?

A

Market capitalisation / earnings
OR
Share price / EPS

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17
Q

What does the P/E ratio give an indication of?

A

The markets perception of the future growth of the business (the higher, the better)

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18
Q

How can we estimate the market value of equity, given the P/E ratio?

A

P/E ratio x current earnings

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19
Q

What is the equation for earnings?

A

PAT minus pref dividends

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20
Q

How can we estimate the value of one share, given the P/E ratio?

A

P/E ratio x EPS

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21
Q

How do we estimate the market value of equity in an unquoted company, with no P/E ratio?

A

Use the P/E ratio of a similar company, adjusted to reflect any differences

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22
Q

Why do we need to adjust down another company’s P/E ratio when using it to value an unquoted company?

A

As listed companies are more desirable than private companies due to liquidity of shares

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23
Q

When valuing a company undergoing change, what value should be used for the earnings element of the calculation?

A

The sustainable earnings available to ordinary shareholders (so removing any distorting/one off costs or revenues)

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24
Q

What are the 4 main advantages of P/E based valuations?

A
  1. Quick to calculate
  2. Considers future potential
  3. Can value unquoted companies
  4. Can value a controlling interest
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25
Q

What are the 3 main advantages of P/E based valuations?

A
  1. May need adjustments to the P/E and earnings figures
  2. Calculations are based on profits rather than cash flows
  3. Uncertainty around what P/E ratio to use
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26
Q

What is the equation for earnings yield?

A

Earnings / Market capitalisation

or EPS / Share Price

or 1 / P/E ratio

27
Q

When is the present value of cash flows suitable for valuing a shareholding?

A

For controlling interests

28
Q

When dividend based cash flow methods suitable for valuing a shareholding?

A

For smaller shareholdings

29
Q

What 2 discount factors can you use when valuing a company by cash flow?

A

Cost of equity (Ke) or WACC

30
Q

When using the cost of equity cash flow valuation method, what cashflows are used?

A

Free cashflows to shareholders - cash flows after interest and tax

31
Q

When using the WACC cash flow valuation method, what cashflows are used?

A

Free cashflows to all investors - cash flows before interest but after tax

32
Q

What is the resulting figure from the cost of equity cash flow valuation method?

A

The market value of equity

33
Q

What is the resulting figure from the WACC cash flow valuation method?

A

The market value of equity + market value of debt

34
Q

What are the 4 steps applied to PBIT for both free cash flow to equity and free cash flow to all investors?

A
  1. Add back depreciation/amortisation
  2. Add proceeds from capital disposals
  3. Deduct capital expenditure
  4. Add decrease/ deduct increase in working capital
35
Q

What are the 2 additional steps applied to PBIT for cash flow to equity?

A
  1. Deduct interest
  2. Add new debt raised/ deduct debt repaid
36
Q

What is the tax deducted from PBIT for both equity and investor cash flow valuations?

A

(PBIT - interest) x tax
and
(PBIT) x tax

((or + deprn - tax deprn))

37
Q

What is meant in an exam by just ‘free cashflow’?

A

Free cashflow to equity

38
Q

Once the free cashflow to equity has been determined, what is the valuation equation?

A

MV EQUITY = FCF * (1+g) / Ke - g

39
Q

Once the free cashflow to investors has been determined, what is the valuation equation?

A

MV EQUITY + MV DEBT = FCF * (1+g) / WACC - g

40
Q

What are the 3 advantages of using cash flow valuation methods?

A
  1. Consider future potential of the business
  2. Can be used to value any business
  3. Considers the time value of money
41
Q

What are the 2 disadvantages of using cash flow valuation methods?

A
  1. Future cash flows will be estimates only
  2. Requires a cost of capital to be estimated
42
Q

What is the dividend yield equation?

A

Total dividend / market capitalisation

43
Q

For an ordinary share, paying an annual dividend d, growing at rate g, what is the ex-dividend value of the share?

A

d*(1+g)/ ke - g

44
Q

What are the 2 advantages of using the dividend growth valuation model?

A
  1. Considers future cash flows to shareholders
  2. Good for minotrity interests
45
Q

What are the 3 disadvantages of using the dividend growth valuation model?

A
  1. Assumes dividends grow at a constant rate forever
  2. Requires a cost of equity to be estimated
  3. Strange results when companies dont pay dividends, or where g > ke
46
Q

What are the 3 types of intellectual capital?

A
  1. Human knowledge/skills
  2. Intellectual assets (e.g. reports, software)
  3. Intellectual property (patented/copyrighted)
47
Q

What 2 things do the value of digital assets heavily depend on?

A
  1. Usage rights of the company (e.g developed or by 3rd party)
  2. The impact of regulatory changes on a company’s ability to utilise
48
Q

What are the 3 methods for valuing intangible assets?

A
  1. Market approach
  2. Cost approach
  3. Income approaches
49
Q

What is the issue with valuing intangible assets at cost?

A

Ignores future revenue generating potential

50
Q

What are the 3 income approaches for valuing intangible assets?

A
  1. PV of cash flows generated
  2. Relief from royalties
  3. Calculated Intangible Value (CIV) method
51
Q

What are the steps of the Calculated Intangible Value (CIV) method?

A
  1. Estimate average excess return expected on tangible assets (PBT - Industry return on assets % x year end tangible assets)
  2. Estimate PV of excess returns as a perpetuity (Excess returns x (1 - tax rate) / WACC)
  3. Estimate the total value of the business (Value of tangibles + CIV)
52
Q

What are the 5 attributes of an efficient market?

A
  1. Share prices are fair
  2. No individual dominates
  3. Transaction costs are not significant
  4. Share prices follow a random walk (rise good, fall bad)
  5. Share prices change quickly to reflect information about a company
53
Q

What is the efficient market hypothesis?

A

The EMH considers how quickly and rationally share prices react to new information, labelled as weak form, semi-strong and strong form efficiency

54
Q

What does the share price reflect in a weak form efficient market?

A

Information about past price moves and past information which has become fact

55
Q

How do you beat the market in a weak form efficient market?

A

Analyse forecasts and the actions of the company

56
Q

When is a positive NPV project reflected in a share price within a weak form efficient market?

A

When its value has been reflected and evidenced

57
Q

What does the share price reflect in a semi-strong efficient market?

A

All publicly available information

58
Q

How do you beat the market in a semi-strong efficient market?

A

Insider trading (illegal)

59
Q

When is a positive NPV project reflected in a share price within a semi-strong efficient market?

A

When a project is announced

60
Q

What does the share price reflect in strong form efficient market?

A

All information about a company

61
Q

When is a positive NPV project reflected in a share price within a strong form efficient market?

A

When the board agree to undertake a project

62
Q

How do you beat the market in a strong form efficient market?

A

Luck

63
Q

What 2 reasons justify offering about current share price?

A
  1. Economic efficiencies from the takeover
  2. Acquisition of a controlling interest
64
Q

Under EMH, which form of efficiency is assumed to generate a fair share price?

A

Semi-strong efficiency

CIMA - F3 (13 decks)

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