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F3 > Ch 12 > Flashcards

Ch 12 Flashcards

1
Q

Factors affecting valuation of a business

A

note: not a scientific process

reported and/or forecasted sales, profits, asset values

type of industry

level of competition

range of products sold

breadth of customer base

perspective - buyer/seller will often have different expectations, thus may value the business differently

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2
Q

Valuation of a quoted company

A

listed company will have stock market value (market capitalization) - if small numbers of shares are being traded, this share price will be used by traders

however, if one company is trying to take over another by acquiring majority of shares, market cap value will not necessarily give suitable value b/c no incentive for sh/h to sell their shares at market price - premium would be req’d

thus stock market price as starting price for valuation, not ending point

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3
Q

Valuation of an unlisted company

A

likely less information published to help a prospective buyer assess value (unless there has recently been a private sale of company shares for known value)

estimates made by applying similar valuation teachniques (cost of equity, beta, P/E ratio, etc.) to similar listed companies (“proxies”) - but not always easy to find a similar listed company

thus an overall discount of 25% to 35% may be req’d against proxy value to account for

(1) relative lack of marketability (b/c unlisted),
(2) lower levels of scrutinty (thus risk of poor fin info), and
(3) higher risk of volatility in earnings b/c smaller / less well regarded entity

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4
Q

Three basic valuation methods

A

ASSET BASED

difficult where high levels of intangible assets, although these too can be valued

EARNINGS BASED

business with high forecasted earnings will attract customers and thus be valued highly

CASH FLOW BASED

theoretically, value should equal PV of future CF discounted at appropriate COC

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5
Q

Overview - Asset Based Valuation

A

entity viewed as being worth the sum of the value of its assets

if only equity is being acquired = deduct borrowings

if physical assets and related liabilities are being purchased (but no liability for borrowings) = don’t deduct borrowings

most useful when company being broken up > purchased as going concern b/c usually gives low figure due to absence of intangible assets (thus more useful in capital-intensive businesses > services)

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6
Q

Three alternative bases for asset valuation

A

BOOK VALUE

little used in practice b/c largely a product of dep’n policy, value of assets on B/S will not reflect reality

REPLACEMENT VALUE

may be relevant if assets will be used on ongoing basis OR if bidder wants to estimate min price that would need paying to buy assets and set up similar business from scratch (esp if intangible asset value can be addewd on)

BREAK UP VALUE / NET REALIZABLE VALUE

individual assets valued at best price obtainable based on second-hand market and urgency orf realizing the asset

can be used to set min price for vendors looking to liquidate the business instead of selling shares

tradeable investments including shares and cryptocurrency should be valued at current market price

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7
Q

Strengths of asset based valuation

A

valuations are fairly readily available

provide a minimum value of the entity

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8
Q

Weaknesses of asset based valuation

A

ignores future profitability expectations

SOFP valuations driven by a/c conventions <> market valuation

difficult to allow for value of intangibles

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9
Q

Shareholder perspective - asset based valuation

A

value given will typically far considerably below market cap value (value of all shares)

thus obviously sh//h (or “the market”) don’t value org based on SOFP assets

sh/h are not buying company for ASSETS but for INCOME the assets can produce

INCOME generated by SOFP assets plus intangible assets - skilled workforce, strong mgmt team, competitive positioning of products

thus SOFP assets only one dimension of overall value (in a normal going concern scenario)

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10
Q

Definition - Intangible Assets

A

intangibles lack physical properties and represent legal rights or competitive advantages developed / acquired by an owner

they should generate some measurable amount of economic benefit in order to have value - e.g. incremental turnover/earnings (pricing, volume); cost savings (process economies); increased market share/visibility

owners can exploit through direct use in business or through indirect use via licensing / royalty fee

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11
Q

Characteristics of intangible assets

A

IDENTIFIABILITY

can be specifically identified with descriptive names, should see some evidence/manifestation of existence (contract, licence, etc.)

should have been created at identifiable time/event and be subject to termination at identified time/event

MANNER OF ACQUISITION

purchased externally or developed internally

DETERMINATE/INDETERMINATE LIFE

determinate life usually established by law/contract or by economic behavior, and should have come into existence at identifiable time as a result of identifiable event

TRANSFERABILITY

int assets may be bought, sold, licensed, rented

subject to rights of private ownership, ensuring a legal basis for transfer

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12
Q

Example Intangible Assets

A

non-physical assets such as franchises, trademarks, patents, copyrights, goodwill, equities, mineral rights, securities and contracts

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13
Q

Definition - Intellectual Capital

A

often used synonymously with IP, intellectual assets, knowledge assets

inellectual capital includes:

HUMAN RESOURCES - collective skills, experience, knowledge

INTELLECTUAL ASSETS - defined and coded assets (drawings, computer programs, data collection)

INTELLECTUAL PROPERTY - items which can be legally protected (copyrights, patents)

can be regarded as total stock of capital or knowledge-based equity that the entity possesses

intellectual capital can be both the end result of a knowledge transformation process, or the knowledge itself that is transformed into IP/intellectual assets of the form

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14
Q

Brands

A

IP increasingly assigns property rights to patents, trademarks, copyrights - these are the only intellectual capitals regularly recognized for a/c purposes

A/C based on historical costs often understates value of IP

company cannot recognize internally-generated goodwill in accounts

on acquisition the value of any brand should be estimated and recognized

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15
Q

Examples of digital assets

A

becoming a major part of many businesses’ intangibles

websites

apps

branding

cryptocurrency

domain names

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16
Q

Regulatory Environment - Digital Assets

A

relatively new phenomenon thus regulations developing

when buying an entity with multiple digital assets, important to consider how current/future reg environment might affect revenue stream potential

e.g. govt interest in how data use affects consumers and markets

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17
Q

Usage Rights - Digital Assets

A

digital assets often created in partnership with 3P consultants - vital to consider usage rights if acquiring an entity with digital assets

due diligence req’d to determine who actually has usage rights

e.g. uncertainty over ownership of code created by 3P consultants could cause buyer to pull out of a potential deal

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18
Q

Valuation of Intangible Assets

A

intangibe assets can be far more valuable than tangibles

may also be of significant importance to sh/h and other st/h, often a key part of IR

basic asset based methods for valuation do not incorporate this value as intangibles are excluded

three basic ways of valuing intangibles:

MARKET approach

COST approach

INCOME approach

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19
Q

Valuing Intangibles - Market Approach

A

comparing an intangible asset to an identical/very similar one recently traded arms length

very difficult to obtain this info - public information usually reflects market cap of entire business, not individual intangibles

may however be possible to find direct market evidence for intangibles, e.g. carbon emission rights, internet domain names, licenses for radio stations

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20
Q

Valuing Intangibles - Cost Approach

A

e.g. internally developed software, websites

historic cost could be easy to identify, but replacement cost is most direct and meaningful way of estimating value

problem - this approach ignores amount, timing, duration of future economic benefits as well as risk of performance in a competitive environment

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21
Q

Valuing Intangibles - Income Approach

A

best used when intangible is income producing / allows an asset to generate CF

converts future benefits to a single discounted amount - usually as a result of increased turnover or cost savings

challenge is identifying those CF which are uniquely related to the intangible asset vs the company as a whole

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22
Q

Relief from Royalty Method

A

a form of income based approach to valuing intangibles

the cost savings (or income enhancements) from using an intangible such as a trademark/patent are directly estimated

value is thus based on the payment that would have been made to a 3P arms length for employing the asset to earn benefits through them

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23
Q

Calculated Intangible Value Method

A

developed to estimate the value of company’s intangibles that do not appear in SOFP

used alongside based asset valuation to give a complete valuation or tang and intang assets

CIV method based on comparison of total return that company is producing vs return expected based on industry average returns on TANGIBLE assets

anything extra is assumed to be return on INTANGIBLE assets

the extra is assumed to continue in perpetuity and can be converted to PV of intangibles by discounting at org’s COC - the result is the “Calculated Intangible Value” or “CIV”

thus total value of entity = value of tangible assets + CIV

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24
Q

Drawbacks of Calculated Intangible Value Method

A

as for basic asset valuation model, based on historical figures

CIV assumes that future growth in income from intangibles will be constant at the COC

CIV based on profit > CF

CIV based on industry average return, may not be representative of the company being valued

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25
Q

Overview - Earnings Based Valuation

A

earnings of the org are forecasted and an “earnings multiple” is applied

multiple could be a negotiated number (e.g. 3x earnings) or a perpetuity factor based on a suitable COC - effectively a discounted CF approach

most commonly used approach is to take a suitable P/E ratio as the earnings multiple

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26
Q

P/E Valuation Method

A

simple method which values the equity of a business by applying a suitable P/E ratio to the business’s earnings (profit after tax)

Value of company equity = total post-tax earnings * P/E Ratio

Value per share = EPS * P/E ratio

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27
Q

P/E Valuation Formula - Post-tax earnings

A

easily found from the published accounts

however, published figures are historical, earnings need to be expected future figure

thus, one-off items should be adjusted before performing the valuation:

  • one-offs which won’t happen again (debt write-offs)
  • director salaries which may be adjusted after a takeover is completed
  • synergies made as part of a takeover
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28
Q

P/E Valuation Formula - P/E Ratio

A

simple measure of company’s share price divided by EPS

indicates the market’s perception of the company’s current position and future prospects - high P/E suggests good growth prospects

unlisted companies have no market share price so a proxy P/E ratio from a similar listed company often used

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29
Q

P/E Valuation Formula - Proxy P/E Ratios

A

proxy ratios also sometimes used when valuing a listed company - if its own P/E ratio were applied to its own earnings, the calculation would simply give the existing share price

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30
Q

Strengths of P/E Method Valuations

A

commonly used and well understood

relevant for valuing a controlling interest in an entity

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31
Q

Weaknesses of P/E method valuations

A

based on accounting profits > CF

difficult to identify a suitable P/E ratio, esp when valuing shares of an unlisted entity

difficult to establish relevant level of sustainable earnings

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32
Q

Earnings Yield Method

A

form of earnings based valuation

earnings yield = reciprocal of P/E ratio

thus

Value of Company = Total Earnings / Earnings Yield

Value per Share = EPS / Earning Yield

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33
Q

Interpretation of Earnings Yield

A

stability of Earnings Yield often as important as growth - the market is absorbing new information to try to assess a sustainable EPS level on which to base future growth

effective growth depends on a stable base, thus trend of Earnings Yield over time is a reflection of this factor

acquirer intentions regarding target - if target entity is to be partially demerged, share price valuation may be higher than if whole target entity were to be retained

however, in this case, potential reduction in goodwill value of acq’n due to break-up considerations, may even damage the acquiring entity itself

34
Q

Dividend Valuation Model

A

DVM theory = value of company/share is PV of expected future dividends, discounted at sh/h required ROR

if we assume all CF to equity are paid out as dividends, DVM therefore gives the same result as valuing a company by discounting CF to equity at cost of equity

35
Q

DVM Formula

A

g = forecast future growth rate in dividends, and:

P0 = Value of company, when d0 = Total dividends

P0 = Value per share, when d0 = Dividends per share

36
Q

Dividend Yield Formula

A

(Dividend/Share price) × 100%

37
Q

Overview - Gordon’s Growth Model

A

developed by economist Myron Gordon

attempts to derive a future growth rate rather than simply extrapolating historical growth rate

Gordon argued that more investment by an org leads to higher future dividends - thus two key elements to determine future div growth are

(1) rate of reinvestment by org and
(2) return generated by investments

38
Q

Formula - Gordon’s Growth Model

A

g = r * b

r = return on invested funds

b = proportion of funds retained

39
Q

Assumptions underpinning Gordon’s Growth Model

A

entity must be enitrely equity financed

retained profits are the only source of additional investment

constant proportion of each yera’s earnings is retained for reinvestment

projects financed from R/E earn a constant ROR

40
Q

Strengths of dividend-based valuations

A

Value is based on PV of future div income stream = sound theoretical basis

div-based valuations are useful for valuing minority sh/holdings where sh/h only receives divs from entity over which he has no control

41
Q

Weaknesses of using DVM

A

forecasting dividends and div growth is very difficult, especially in perpetuity

  • how can we predict there will be sufficient worthwhile projects to invest in for ever?
  • a company with no dividend history would receive a zero score but may actually be worth something

difficult to estimate cost of equity, esp for unlisted companies

for unlisted companies, a consistent dividend policy with constant growth rate is unlikely

42
Q

Uneven Growth Rates

A

DVM cannot be used directly when annual growth rate is expected to change

in this case the entity lifespan should be segmented into the periods for which varying rates apply, and each valued separately

43
Q

Example - DVM Model

A

org has just paid 250k div, has 2m shares in issue

current industry-wide return to sh/h is 12%, org has addnl 2% risk premium as is unlisted

calculate expected valuation of org if dividends stay constant for 3 years and then grow at 4% per year

Years 1-3

250,000 * AF 1-3 (14%) = 250k * 2.322 = 0.580m

Year 4+

DVM Formula, then adjust for start in year 4, not year 1

[(250*1.04)/0(.14-0.04)] * DF3 (14%) = 1.755m

Total value = 1.755m + 0.580m = 2.335m

per share = EUR 1.17

44
Q

Summary on DVM

A

demonstrates underlying principle that company is worth the sum of its discounted future CF

however, based on a very simplistic model

does however provide a useful analytical tool for investors to evaluate different assumptions about growth and future prospects

challenge is to make the model as applicable to reality as possible, thus using the most reliable assumptions available

45
Q

Overview - Discounted Cash Flow Method

A

value for the equity of an entity derived by estimating future annual post-tax CF of entity and then discounting at an appropriate COC

theoretically the best way of valuing a business, since the discounted value of future CF represents sh/h wealth

COC used to discount CF should reflect the systematic risk of the CF

46
Q

Cash Flows to Equity

A

ideally, cash flows to equity should be used in DCF valuations > post-tax post-fin CF

CF to equity similar to post-tax post-fin CF, except that they include average sustainable levels of net CF investments in capital and working cap over the longer term rather than this year’s figures

post-tax post-fin CF often used as approximation for CF to equity, but CF2E should be used wherever information permits it to be computed

47
Q

Concept of Free Cash Flow

A

cash generated by the business that is “freely” available for distribution to investors after having met all immediate obligations and investment in working cap and NCA required to sustain ongoing operations

48
Q

Definition - Cash Flow to Equity

A

CF generated by the company after tax, reinvestment needs, and debt-related CF

thus CF attributable to equity investors

49
Q

Definition - CF to all investors

A

CF generated by company after tax and reinvestment needs but before debt-related CF

thus, CF attributable to all investors = debt and equity investors

50
Q

Definition - Free Cash Flow

A

Free Cash Flow to Equity

sustainable CF to equity

Free Cash Flow to all investors

sustainable CF to all investors

51
Q

Use of CF to equity

A

value of sh/h stake/equity in an entity is the sum of future CF to equity discounted at COE

note - if we assume that org pays out all CF2E as divident, the DCF company valuation method (CF2E discounted at COE) will give exactly same result as DVM method

52
Q

Valuation of businesses using Discount Cashflow Method

A

harder to quantify and identify CF generated b/c there are so many and the necessary information does not exist in the public domain

thus, for business valuation, we hve to estimate CF using readily-available a/c info

53
Q

Step-by-step - calculating Cash Flow to Equity from profit data

A

(1) start with PBIT
(2) deduct tax for year* and interest, to give profit for the year
(3) adjust for non-cash items (e.g. add back dep’n)
(4) adjust for cash items such as capex/NCA disposal; changes in working cap; new debt raised/debt repaid

* tax calculated as

(PBIT - interest) x tax rate

if tax dep’n allowances differ from dep’n:

(PBIT + dep’n - tax dep’n allowance - interest) x tax rate

54
Q

Step-by-step - calculating Cash Flow to all investors from profit data

A

(1) start with PBIT
(2) deduct tax for the year, excluding tax relief on interest*
(3) adjust for non-cash (dep’n)
(4) adjust for cash items such as capex/NCA disaposal; working cap changes

* tax calculated as

PBIT x tax rate

if tax dep’n allowances differ from dep’n, tax is

(PBIT + dep’n - tax dep’n allowances) x tax rate

55
Q

Determining an appropriate cost of capital

A

USE OF COST OF EQUITY as discount rate

COE can be used to discount CF TO EQUITY (i.e post-tax cash flows after financing charges) in order to value the equity in a company directly

USE OF WACC as discount rate

WACC can be used to discount CF TO ALL INVESTORS (i.e. post-tax CF BEFORE financing charges) when valuing debt+equity value or project or entity

USE OF PROXY COMPANY

when COC info not given or difficult to derive

56
Q

Summary Diagram - entity value and selection of COC

A
57
Q

Strengths of cash-based valuation

A

theoretically the based method

can be used to place a max value on entity

considers the time value of money

58
Q

Weaknesses of cash-based valuations

A

difficult to forecast CF accurately

difficult to determine an appropriate discount rate

what time period should be evaluated in detail, and how is org’s worth valued beyond this point?

basic NPV method does not evaluate existence of further options - although can be modified using decision trees/probabilities to assess sensitivity of results to potential CF variations

basic model assumes constant discount rates and tax rates - again this can be overcome using sensitivity analysis / other ways of analyzing risk (probs, decision trees)

59
Q

Overview - Capital Asset Pricing Model

A

CAPM enables us to calculate required return from an investment given level of associated risk measured by beta-factor

gives a req’d ROR for a given risk level (measured by beta factor)

if we can estimate level of risk associated with an entity (beta of the entity) CAPM can be used to give a required return to sh/h

this required return is essentially the COE, which can then be used to derive an appropriate WACC for the entity

60
Q

Definition - systematic and unsystematic risk

A

UNSYSTEMATIC / SPECIFIC

risk of company CF being affected by specific factors

strikes, R&D success, systems failure

can be eliminated by DIVERSIFICATION

SYSTEMATIC / MARKET

risk of company CF being somehow affected by general macroeconomic factors

tax rates, unemployment, interest rates

cannot be eliminated

61
Q

CAPM - impact of diversification

A

holding a portfolio of approximately 25 shares enables an investor to diversify away the unsystematic risk while the systematic risk will remain

CAPM enables calculation of required return for well-diversified investor not subject to unsystematic risk

if we can measure the systematic risk of a company/investment, CAPM will enable calculation of level of required return

62
Q

CAPM - ß (beta) factor

A

method adopted by CAPM to measure SYSTEMATIC/market risk

ß (beta) factor is measure of share’s volatility in terms of market risk

beta-factor of market as a whole is 1 - it is a yardstick against which risk of other investments can be measured

63
Q

CAPM - interpretation of beta-values

A

ß > 1

shares have MORE systematic risk than stock market average

ß = 1

SAME systematic risk

ß < 1

LESS

ß = 0

NO RISK

ß = 1.25

25% MORE RISK

etc

64
Q

CAPM - Security Market Line (SML)

A

gives the relationship between systematic risk and return - two relationships:

(1) RISK FREE SECURITY

no risk, no systematic risk, thus ß of zero

Rf on graph

(2) MARKET PORTFOLIO

ultimate in diversification, thus contains only systematic risk, ß of 1

Rm on graph

higher systematic risk = higher rate of return required

65
Q

CAPM - Security Market Line formula

A

ke = Rf + [Rm – Rf] ß

where

ke = required return from individual security

ß = beta factor of individual security

Rf = risk-free rate of interest

Rm = return on market portfolio

MARKET PREMIUM = diff between Rf and Rm

66
Q

CAPM - Calculating Beta Factors

A

calculated statistically from past observed returns

is it reasonable to use a history-based beta factor to make decisions about the future? are beta factors stable over time?

highly diversified shares (e.g. investment trusts) => stable beta value b/c companies carry on same areas of business in long term

longer period of data => higher quality calculation

67
Q

CAPM - Alpha Values

A

say CAPM states we should expect average annual return of 16.5%

this does not means shares will produce a return (dividend yield plus capital gain) of 16.5% each year

shares are a risky investment and returns are not certain

thus an 18% return is a +ve “abnormal” return of 1.5%

the alpha value of a share is its average abnormal return - e.g. alpha of +2% means an average return of 18.5% in recent past

alpha values reflect that world isn’t perfect and actual returns don’t always match those indicated by CAPM

68
Q

Criticisms of CAPM

A

(1) single period model - values calculated are only valid for a finite period and need recalculating or updating regularly
(2) CAPM assumes no tx costs associated with trading securities
(3) any beta value calculated is based on past information, may no longer be appropriate (esp if company has changed type of business or capital structure)
(4) risk free rate may change considerably over short periods of time
(5) CAPM assumes an efficient investment market where possible to diversify away risk - not necessarily possible, thus some unsystematic risk may remain
(6) idea that all unsystematic risk can be diversified away does not hold true if stocks change in terms of volatility
(7) CAPM assumes all stocks relate to going concerns, this may not be the case

69
Q

CAPM - Asset Betas, Equity Betas, Debt Betas

A

BETA FACTOR

measure of systematic risk of an entity relative to the market

this will depend on level of business risk and financial risk (gearing) associated with an entity

thus, beta factor for a geared company > equivalent ungeared company

70
Q

Formula - beta factors for geared/ungeared companies

A

ßg = the equity (geared) beta measures the systematic business risk and the systematic financial risk of a company’s shares

ßu = the asset (ungeared) beta measures the systematic business risk only

ßd = the debt beta measures the risk associated with the debt finance. Usually we assume that debt is risk free and hence the debt beta is zero

71
Q

CAPM - Systematic Risk - more info

A

Shareholders only interested in systematic risk because they all have well-diversified portfolios

An entity’s systematic risk is measured by its BETA

Shareholders in a geared company suffer two types of systematic risk - business risk, financial risk

Business risk = risk to operating CF

Financial risk = increased volatility of dividend payment to shareholders as gearing increases

72
Q

CAPM - Systematic Risk - Modigliani & Miller

A

a share’s systematic risk can be further subdivided:

Systematic BUSINESS risk

arises out of risky nature of company’s business caused by revenue sensitivity, proportion of fixed to variable prod’n costs

Systematic FINANCIAL risk

how the company has financed itself - gearing/capital structure

73
Q

Use of the beta formula

A

ABC company has gearing ratio (D:E) of 1:2, shares beta value 1.45, corp tax rate 30%

beta value/systematic risk exposure is 1.45

attached formula gives betaU (systematic business risk only) of 1.074

thus 1.45-1.074 = 0.376 arises out of financial risk caused by company’s capital structure

74
Q

Implications of using the beta formula

A

a company’s equity beta ßg (systematic business + financial risk) will always exceed its asset beta ßu (systematic business risk only)

unless entity is all equity financed - thus no debt - thus the two are the same

companies in the same area of business have the same business risk thus the same asset beta

companies in the same area of business will have different equity betas unless they also happen to share capital structures

75
Q

Gearing/Degearing Formula - Application to business valuation

A

two ways to use the formula to derive COE and/or WACC for use in business valution

both methods assume you have been given an equity beta for a proxy company

METHOD ONE

use the formula to derive proxy’s ungeared beta factor

assume this beta factor also reflects business risk of entity X being valued

regear this ungeared beta factor with X’s actual capital structure

then use CAPM to derive COE for X and use this ke to find WACC (if required)

METHOD TWO

use formula to derive proxy’s ungeared beta factor

use CAPM to find ungeared COE (keu) for proxy

assuming proxy’s keu as keu of X (same business risk), use M&M’s WACC formula to calculate WACC of entity being valued

76
Q

Definition - Effecient Market Hypothesis

A

level of efficiency in market is important when considering value of business

EMH says that the share price is a sum of all known information aout the company - thus always “fair” and a true valuation - never under or over valued

thus, without additional information not currently wrapped into share price, an investor can never beat the market

higher returns are thus only possible by investing in higher risk investments (higher beta factor)

77
Q

Efficient Market Hypothesis - Weak Form of Efficiency

A

WEAK FORM OF EFFICIENCY

share price reflects any/all information that can be discerned from past trends in share prices

day traders trying to speculate / predict future mvmts based on past trends are wasting their time

e.g. a speculator buying shares that are going to increase in price will push up the price

78
Q

Efficient Market Hypothesis - Semi-Strong Form of Efficiency

A

SEMI-STRONG FORM OF EFFICIENCY

share price reflects all information publicly available

analysts studying financial reporting to identify mispriced shares are wasting their time

could however be possible to benefit from ability to follow news real-time and respond to events before they become public knowledge

investors generally subscribe to info sources which povide news before broadcast

their responses will enable tmarket to update itself - e.g. flurry of sales by major investors signalling that “bad” news has become available

79
Q

Efficient Market Hypothesis - Strong Form of Efficiency

A

STRONG FORM OF EFFICIENCY

share price reflects all information, even that not made publicly available

does not seem credible - but info may have been leaked due to insider trading

market may not know why blocks of shares are being traded, but trading activity suggests someone knows something and prices may respond accordingly

80
Q

Efficient Market Hypothesis (EMH) - Impact on Business Valuation

A

EMH does not mean it is wrong to pay a premium over market price to acquire control

bidder is usually hoping to benefit from exploitable strategy

however, EMH suggests that markets will take possibility of a future bid into account in seting prices

81
Q

Summary - Efficient Market Hypothesis (EMH)

A

WEAK FORM OF EFFICIENCY

suggests that patterns of past trades can be a sign of a future bid

SEMI-STRONG EFFICIENCY

suggests that any information suggesting possibility of a bid will affect the price (e.g. loss-making company that requires support only obtainable from being incorporated into a larger group)

STRONG FORM EFFICIENCY

suggests that share prices could rise because a dishonest employee could signal possibility of positive news by buying up shares in target company

82
Q

Valuation Methods - which are most useful when?

A

ASSET BASED METHODS

when valuing capital intensive businesses with plenty of tangible assets

service businesses will be significantly undervalued (unless work put in to value intangibles)

however, in times of uncertainty, asset based if favored as avoids the needs to forecast future earnings/CFs

DIVIDEND VALUATION MODEL (DVM)

valuing a minority sh/holding - b/c a minority owner’s dividends represent forecast income from investor, which will impact wealth

in majority stake scenario - more relevant to consider overall company CF or asset values as basis for valuation

P/E METHOD AND DISCOUNTED CF METHOD

both based on future forecasts and often using proxy information - difficult to identify in practice

providing accuracy of forecasts, these methods value a business based on future prospects and thus automatically include a measure of associated goodwill/intangibles

for this reason, generally preferred by service businesses vs asset based methods

F3 (13 decks)

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