Business 6: Financial Valuation Flashcards
What is an annuity?
Series of equal CFs to be received over a # of periods
How do you calculate the PV of an annuity?
= PMT
* ( 1 - [ 1 / (1+r)^t ] / r)
Does does an annuity due occur?
Beginning of period
When does an ordinary annuity occur?
End of period
A perpetuity is also known as what?
Zero growth stock
What is a perpetuity?
Period CFs paid by an annuity that lasts forever
How do you calculate a perpetuity?
= stock value per share
= price
= dividend / required return
What is another name for the Gordon model?
- Dividend Discount Model (DDM)
- Constant Growth DDM
What model assumes that the dividend payments are the CFs of an equity security and that the intrinsic value of the company’s stock is the PV of the expected future dividends?
Gordon model
How do you calculate the price of the stock using the Gordon model?
= D1
/ (R-G)
How do you determine the required rate of return?
CAPM
= Rf + B (Rm - Rf)
What do price multiples represent?
Ratios of a stock’s market price to another measure of fundamental value per share
What do investors use price multiples to evaluate?
- Price of stock AND
- Determine if it undervalued, fairly valued, or overvalued
Why is the P/E ratio the most widely used multiple when valuing equity securities?
- Earnings is key driver of investment value
- Changes in company’s P/E tied to long run stock performance of that company
How do you calculate the P/E ratio?
= P0 / E1
= Price today / EPS expected in one year
How do you value the stock with the P/E ratio?
= [P0/E1] * E1
When past earnings are used in the P/E ratio, what is the name of the ratio calculated?
Trailing P/E
When expected earnings are used in the P/E ratio, what is the name of the ratio calculated?
Forward P/E
When is the trailing P/E the preferred calculation method?
When co. forecasted earnings unavailable
When is the forward P/E the preferred calculation method?
When co. historical earnings not representative of its future earnings
How do you calculate the trailing P/E ratio?
= P0 / E0
= Price today / EPS for the past year
What does the PEG ratio show?
Price-earnings growth
- effect of earnings growth on a co. P/E
- assuming a linear relationship b/w P/E and growth
True or false.
Generally stocks with higher PEG ratios are more attractive to investors than stocks with lower PEG ratios.
FALSE (lower PEG = more attractive)
How do you calculate the PEG ratio?
= (P0 / E1) / G
= (Price today / Expected earnings in a year)
/ (100 * expected growth rate)
How would you value stock with the PEG ratio?
= PEG * E1 * G
= PEG
* Expected earnings in one year
* (100 * Expected growth rate)
Which ratio is more volatile: price to sales ratio OR P/E ratio?
P/E ratio
Which is more subject to manipulation: earnings OR sales?
Earnings
How do you calculate the price-to-sales ratio?
= P0 / S1
= Price today / Expected sales in a year
How do you value equity with the price-to-sales ratio?
= (P0 / S1) * S1
What does empirical research show about changes in a company’s P/CF ratios over time?
Positively related to changes in a co. LT stock returns
How do you calculate the P/CF ratio?
= P0 / CF1
= Price today / Expected CF in a year
How do you value equity with the P/CF ratio?
= (P0 / CF1 ) * CF1
Which price multiple is used by analysts that focus on the B/S versus the I/S or statement of CF?
Price-to-book ratio
What is the rationale for using the P/B ratio?
- firm’s BV of common equity is more stable that EPS
- esp. when firm’s EPS is extremely high or low for a given period
How do you calculate the P/B ratio?
= P0 / B01
= Price today / BV of common equity today
How do you value equity with the P/B ratio?
= (P0 / B01) * B0
= (Price today / BV of common equity today)
* Book value of common equity today
What type of finance examines investor behavior and how this behavior affects financial markets?
Behavioral finance
Behavioral biases often distort what?
Judgement
What is the name of this behavioral bias:
“erroneous belief that the financial manager has control over valuation outcomes that are ultimately the result of market forces”
Illusion of contrl
What is the most common model used for valuing options?
Black-Scholes Model
David wants to buy shares of Epoch Corporation. If he uses a zero growth model, a desired rate of return of 20% and a dividend of $10, what was Epoch’s price?
$50
= Dividend / Required return
= $10 / 0.20
A company’s PEG ratio is 4x and its current EPS is $10. Growth is expected to be 2.5%. What’s the projected stock price?
$102.50
( = PEG * E1 * G)
( = 4 * 10.25 * 2.5)
Which valuation technique can be adapted to start up companies and other situations where earnings are very low?
Price-Sales ratio
What formula should be used to calculate the economic rate of return on CS?
(Dividends + change in price)
Divided by beginning price
