Ch 7: corp & stock valuation

Question 1

proxy

proxy fight

Answer 1

1. document giving one person authority to act for another, typically the power to vote shares of common stock
2. attempt to take over a company in which an outside group solicits existing shareholders’ proxies in an effort to overthrow management and take control of business.

Question 2

preemptive right

Answer 2

allows current common stockholders to purchase any additional shares sold by the firm. it allows the current to maintain control and prevents transfer of wealth from current stockholders to new stockholders. if not for this, management could issue additional shares at a low price and purchase the shares themselves.

Question 3

classified stock

founders shares

Answer 3

1. created by a firm to meet special needs and circumstances (dividend and voting rights)

dual class shares if there's 2 classes.
New shares in IPO sometimes have voting restrictions but may have full dividend rights.

2. stock owned by firm’s founders that have sole voting rights but restricted dividends for a specific # of years. Standard & Poor’s no longer allows new additions to its indices to have classified stock.

Question 4

free cash flow (FCF) valuation model

Answer 4

shows the connection between managerial choices and firm value. defines the value of a company’s operations as the present value of its expected FCF when discounted at the WACC.

Question 5

importance of FCF model

Answer 5

managerial choices that change operating profitability, asset utilization, or growth also change FCF, hence, the value of operations. Managerial choices that affect risk, such as implementing riskier strategies or changing the amount of debt financing also affect the WACC, which affects the company’s value.

Question 6

entity value

Answer 6

total value of a company. 2 primary sources of value- value of ops and nonoperating assets. 3 major types of claims on this value are debt, preferred stock and common stock.

Question 7

value of operations (Vop)

Answer 7

present value of all expected future FCF when discounted at the WACC

Question 8

primary source of value for companies

Answer 8

value of operations. second source is from nonoperating assets. (financial assets) 2 major types: 1) ST investments that are very marketable securities (t bills) and temporarily held for future needs rather than to support current ops. and 2) other nonoperating assets which are investments

Question 9

tracking stock/target stock

Answer 9

The dividends of tracking stock are tied to a particular division, rather than the company as a whole.
Investors can separately value the divisions.
Its easier to compensate division managers with the tracking stock.
But tracking stock usually has no voting rights, and the financial disclosure for the division is not as regulated as for the company.
Very few companies have tracking stock anymore

Question 10

different approaches of valuing common stock

Answer 10

Free cash flow model: Constant growth and Non-constant growth
Dividend growth model: Constant growth and Non-constant growth
Using the multiples of comparable firms or industries

Question 11

Claims on Corporate Value

Answer 11

Debtholders have first claim.
Preferred stockholders have the next claim.
Any remaining value belongs to stockholders.

Question 12

entity valuation model

Answer 12

estimates the total value of a corporation rather than just the values of debt or stock

Question 13

What happens to 〖 [(1+g_L)/(1+WACC)]〗^t as t gets large?

Answer 13

If gL < WACC: Then 〖 [(1+g_L)/(1+WACC)]〗^t < 1.
If gL ≥ WACC: Then 〖 [(1+g_L)/(1+WACC)]〗^t ≥ 1.

g can’t be greater than or equal to WACC

Question 14

constant growth model

Answer 14

formula for the present value of an infinite stream of constantly growing cash flows.

1. only applies if the expected growth is constant and less than the WACC
2. calculates PV of cash flows from t=1 not t-0

Question 15

multistage valuation model

Answer 15

used to find the PV of cash flows that grow at a nonconstant rate for multiple period before eventually growing at a constant growth rate for infinity. sum of PV of all cash flows during the forecast period + PV of the horizon value.

Question 16

steps in multistage valuation model

Answer 16

1. forecast expected free cash flows and calculate the annual growth rate for each year in the forecast - continue doing until the growth rate in FCF is expected to be constant. the last year in the forecast is the forecast horizon/horizon date/terminal date.
2. bc expected growth is constant after the horizon date, you can apply the constant growth model to estimate the value of ops at the horizon year.
3. create a TL with the FCF for each year up to the horizon date. includes horizon value and date. there will be 2 cash flows on the horizon date.
4. discount the cash flows in the TL using the WACC. the result is the estimated value of ops as of t=0

Question 17

horizon value/terminal value/continuing value

Answer 17

value of all FCF beyond the horizon discounted back to the horizon
how much the operations would be worth if they were sold right after receiving the FCF at the horizon date.

Question 18

are stock values more affected by short term or long term cash flows

Answer 18

long term, company probably increased its R&D expenditures.

Question 19

key inputs to the FCF valuation model

Answer 19

1. most recent level of sales
2. most recent level of net operating capital
3. projected sales growth rates
4. projected operating profitability ratios
5. projected capital requirement ratios
6. WACC
   changes to these will cause intrinsic value of ops to change

Question 20

value drivers

Answer 20

subset of inputs that managers are able to influence through strategic choices and execution of the resulting business plans. bc managers can’t change the past, the most recent level of sales and operating capital aren’t value drivers but the others are.

Question 21

value based management

Answer 21

systematic use of the FCF valuation model to identify value drivers and guide managerial and strategic decisions

Question 22

effect of value drivers on horizon value

Answer 22

1. an increase in the ROIC has positive effect on horizon value because it increases the numerator.
2. reduction in the cost of capital increases numerator and decreases the denominator –> positive effect on the horizon value and current value of ops
3. increase in growth rate can have + or - effect on horizon value. if numerator is negative then then bracket term is less than 1 causing the intrinsic value of ops at the horizon to be less than the amount invested in op capital. basically earning a return that isn’t enough to compensate investors for the cost of using their capital.

Question 23

what causes stocks to be so volatile?

Answer 23

readily available information (initial sales of a new product, results for an R&D program, etc) causes stock prices to be volatile

if a stock is stable, its not gettin new information

Question 24

constant dividend growth model / Gordon model

Answer 24

formula for the PV of an infinite steam of constantly growing dividends.

if growth rate is not less than rate of return, the company is not in its constant growth phase. \

Question 25

market multiple method

Answer 25

some analysts use to target company’s value.
Steps:
1. identify a group of comparable firms.
2. calculate each comparable firm the ratio of its observed market value to a particular metric, which can be net income, earnings per share, sales, book value, # of subscribers, or any other metric that applies to the target firm and comparable firms. this ratio is called market multiple.

to estimate the target firm’s market value, the analyst would multiply the target metric by the comparable firms’ average market multiple.

Question 26

entity multiple

Answer 26

for a group of comparable firms, the avg ratio of the observed market entity value to a particular metric that applies to a whole firm (any metric that applies to the entity values of the target firm and comparable firms)

Question 27

which model should you use

Answer 27

free cash flow valuation model - apply for high growth companies even if they are paying dividends because you would need to project future financial statements before you could make a reasonable estimate of future dividends –> then apply either corp valuation or dividend growth. useful when considering the sale or purchase of a division.

corporate valuation model- trying to estimate the value of a company that has never paid a dividend or a private company.

dividend growth model- financial analyst estimating the value of a mature company whose dividends are expected to grow steadily in the future.

Question 28

preferred stock

Answer 28

hybrid. similar to bonds in some respects and to common stock in others. fixed amount and must be paid before common stock dividends can be paid.