Chapter 9

Question 1

2 Investment Styles

Answer 1

• Growth share or earnings momentum investing
• Value investing

Question 2

Growth Share investing

Answer 2

Supports the premise: good companies are good investments.

Question 3

Value investing

Answer 3

Undervalued shares are good investments.

Looks for a “margin of safety” reflected by the discount below intrinsic value at which a share is priced.

Question 4

8 Type of companies in value investing

Answer 4

• Growth companies
• Growth shares
• Defensive companies
• Defensive shares
• Cyclical companies
• Cyclical shares
• Speculative companies
• Speculative shares

Question 5

Growth companies

Answer 5

Companies with the management capability and the opportunity to undertake investment projects that produce rates of return greater than their weighted average cost of capital.

Question 6

Growth shares

Answer 6

Shares with above-average expected rates of return given their risk.

Generally undervalued shares with a reasonable prospect of becoming properly valued in the near term

Question 7

Defensive companies

Answer 7

Not likely to react sharply to a decline in the general level of economic activity.

Question 8

Defensive shares

Answer 8

Shares with low betas, regardless of the nature of the company.

Question 9

Cyclical companies

Answer 9

Companies whose sales and earnings tend to rise and fall sharply with fluctuations in the business cycle.

Question 10

Cyclical shares

Answer 10

High-beta shares whose returns rise and fall sharply in bull and bear markets.

Question 11

Speculative companies

Answer 11

Forms whose business involves great risk.

Question 12

Speculative shares

Answer 12

Overpriced shares whose returns might be abnormally low because of their overvaluation.

Question 13

Added value

Answer 13

Profit in excess of the firm’s cost of capital (economic profit).

Question 14

Economic value added (EVA)

Answer 14

EVA is net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise. By taking all capital costs into account, including the cost of equity, EVA shows the dollar amount of wealth a business has created or destroyed in each reporting period.

Question 15

Cash Value Added

Answer 15

Net present value model that uses the net present value approach to calculate company value.

Question 16

CVA: 2 Investment categories

Answer 16

• Strategic investments
• Non-strategic investments

Question 17

CVA Index

Answer 17

^{Operating cash flow}/ _{Operating cash flow demand.}

Question 18

Market Value Added

Answer 18

Difference between the firm’s total value and the total capital that investors have committed to it.

MVA = Total Value - Total Capital

Question 19

Total Value (MVA)

Answer 19

Market value of debt and equity

Question 20

Total Capital (MVA)

Answer 20

Adjusted total assets from the statement of financial position (according to EVA).

Question 21

Sources of Value added

Answer 21

• Economies of scale
• Economies of scope
• Cost advantages
• Product differentiation
• Access to distribution channels
• Government policy

Question 22

4 Techniques

Answer 22

• 2-stage dividend discount model
• H-model
• 3-stage dividend discount model
• Growth duration model

Question 23

Disadvantages to the Dividend Discount Model

Answer 23

• Models only apply to dividend paying shares, or to shares that may not pay a dividend currently, but a dividend stream can be projected in the future.
• Risk is not an explicit variable of the models.
• Analyst’s estimates of g and r_s (cost of equity capital) may be in error.
• Small changes in r_s and g produce large differences in valuation.
• Models don’t reflect the value of under-utilised assets.
• Model tends to orient investors towards high yielding shares.

Question 24

5 Major Value Drivers of CVA

Answer 24

• Operating Surplus
• Working capital movement
• Non-strategic investments
• Operating cash flow demand
• Sales