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Financial Management > Business Valuation and Market Efficiency > Flashcards

Business Valuation and Market Efficiency Flashcards

1
Q

Identify 6 reasons for valuing business and financial assets

A
  1. Establish terms for takeovers/mergers
  2. Make ‘buy and hold’ decisions
  3. Value companies entering the stock market
  4. Value shares for retiring directors which articles of a company specify must be sold
  5. Fiscal Purposes (CGT, Inheritance tax)
  6. Divorce settlements
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2
Q

What are the 3 main approaches to valuations?

A
  1. Asset Based ( Tangible assets owned)
  2. Income/earnings based ( returns earned)
  3. Cashflow based
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3
Q

How is a firm’s market capitalisation found?

A

By multiplying its current share prince with the number of shares in issue

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4
Q

The real worth of a company depends on the viewpoints of various parties and is therefore …

A

Subjective.

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5
Q

Give 5 examples of things which could be useful in valuing a business.

A
  1. Financial statements
  2. Supporting listings (inc NCA and Depreciation schedule)
  3. Details of existing contracts
  4. Budgets/projections for the future
  5. Background info on industry and key personnel
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6
Q

Give 3 types of asset based valuation measures

A
  1. Book Value
  2. Net realisable value ( Minimum acceptable to owner)
  3. Replacement cost - going concern ( Maximum to be paid by buyer)
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7
Q

Identify 2 fundamental weaknesses of asset based valuations, and a subsidiary weakness

A
  1. Investors normally buy a company for its earnings/cashflow, not its statement of financial position
  2. We should value based on what is being purchased. Ie future income/cashflows
  3. Ignores Non statement of FS intangible assets such as a skilled workforce, strong management team and competitive position of the company’s products.
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8
Q

How do you calculate a PE ratio?

A

Earnings per share

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9
Q

How do you use a PE ratio to value a company?

A

Value of company = Total earnings x PE ratio

Value per share = EPS x PE ratio

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10
Q

You may need to adjust the PE ratio (10%per reason) if the company be valued….:

A
  1. is a private company as its share may be less liquid
  2. is a more risky company with fewer controls and management knowledge
  3. has a high projected growth level
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11
Q

What does a high PE ratio indicate?

A
  • Growth stock - continuous high rate of growth expected
  • no growth stock- PE based on low past earnings, Price based on future earnings.
  • take over bid
  • High security share
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12
Q

What could a low PE ratio indicate?

A
  • Losses expected

* Share price is low (volatile)

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13
Q

What is the earnings yield valuation method?

A

EPS/ share price

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14
Q

How do you value one share in a company using the Earnings Yield?

A

Value of one share = EPS of company/ Suitable earnings yield

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15
Q

As with the P/E method, earnings yield is used to value a …

A

controlling interest in a company

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16
Q

Give two methods of cash flow based valuations

A
  1. Dividend valuation model

2. Discounted cash flow

17
Q

What is the dividend valuation model?

A

The growth model which values a business based on the present value of future dividends discounted at the cost of equity.

18
Q

What are the weaknesses of the Dividend valuation/growth model?

A

Assumes that dividends grow at a constant rate
Future dividend growth is predicted from past results
Cost of Equity may fluctuate in the future
What if Ke is less that the growth rate?!

19
Q

Discounted cashflows is based on forecasting future cash flows and effectively calculation an NPV. What are its weaknesses?

A

Estimating the cashflows

Finding a suitable discount rate

20
Q

The present value of the future cash-flows that an investor will receive, discounted at the investors required rate of return is…

A

The value of a bond

21
Q

In valuing bonds, the investors required rate of return is the same as…

A

pre-tax cost of debt or yield.

22
Q

Irredeemable debt is where interest will be paid in…

A

perpetuity

23
Q

The market value of a bond is the discounted present value of future interest payments up to the year of redemption, plus the discounted present value of the redemption payment. This is the value of:

A

Redeemable debt.

24
Q

When valuing redeemable debt, the cashflows are discounted at…

A

pre-tax cost of debt.

25
Q

Efficient Market Hypothesis is concerned with what?

A

How efficient the stock markets are at pricing shares and whether they accurately reflect the information about a company.

26
Q

What are the three types of efficiency regarding EMH?

A
  1. Weak form
  2. Semi-strong
  3. Strong
27
Q

‘Past share price movements, past information such as sales volume, earnings etc are already reflected in the share price of a company.’ Which type of efficiency is this?

A

Weak Form

28
Q

‘There’s no point in an analyst looking at historic information to predict the share price as it’s already reflected.’

A

Weak Form

29
Q

If a market is efficient a share price will follow …

A

a random walk

30
Q

Share price is considered to reflect all past information and all publicly available information. New information released is reflected immediately in the share price

A

Semi-Strong form

31
Q

There is no point in an analyst studying pubilcally available information to predict future share price .

A

Semi-strong form efficiency

32
Q

This type of market reflects all information whether publicly available or not.

A

Strong form market.

33
Q

How does the EMH assume investors behave?

A

Rationally

34
Q

Give 3 reasons an investor may behave irrationally?

A

Herding
Loss aversion
Momentum effect

35
Q

What is herding?

A

They do it because everyone else is. This can result in stock market bubbles or crashes

36
Q

What is loss aversion?

A

The fear of making a loss and therefore choosing low, stable profits over distorting demand for shares.

37
Q

What is the momentum effect?

A

If Share prices start to rise significantly, investors become optimistic about the future. The opposite is also true, making booms and busts last longer.

Financial Management (18 decks)

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