Chp 12: Introduction to Valuation Methods Flashcards
What do the three degrees of market efficiency mean?
Weak form; Semi-strong form; Strong form
Weak form - Share prices reflect all historcial information like recurring patterns
Semi-strong form - Share prices also reflect all publicly available information
Strong form - Share prices also reflect information held privately by directors
What is efficient market hypothesis?
That the stock market will respond immediately to all available information so that investors cannot expect a greater than average return in the long run
What is the asset valuation method?
Valuing a company based on their net assets (deduct borrowings if the equity is being acquired, as the liability is also being purchased)
May be used as a ‘floor’ value for a business up for sale or as a measure of the ‘security’ in the share value
What are two strengths and three weaknesses of the asset valuation method?
Strenghts
1. Information readily available form financial accounts
2. Provides a minimum value
Weaknesses
1. Ignores future profitability
2. Excludes most intangible assets
3. Depends on the companies accounting policies
What are the two steps to the Caluclated Intangible Value (CIV) method?
- Estimate the post-tax profit that would be expected from an entity’s tangible asset base using an industry standard expected return
- Calculate the present value of any excess profits that have been made in the recent past. Do this by dividing it by the WACC as a discount factor (which treats it as a perpetuity)
Add this onto the value of the tangible assets for the company value
Intangible asset value can also be calculated as the difference between book value and market value
What are three drawbacks to using Calculated Intangible Value (CIV) method?
- Uses industry average figures
- Assumes past performance is a sound basis for future performance
- Assumes no growth in profits
How would you adjust the Dividend Growth Model (DVM) to account for more than one growth period?
- Use the normal NPV calculation for the first phase of dividend growth.
- Then for the ‘remaining’ growth, adjust d1 in the formula to be dx and carry out as normal. Then discount it back the the present value. So if it’s a different growth rate in 4 years then discount it back at a time 3 disctoun factor to have it at the present value
What are two strenghs and three weaknesses of the Dividend Valuation Model (DVM)?
Strengths
1. Based on the PV of future cash flows received
2. Good for valuing a minority interest
Weaknesses
1. Difficult to forecast future dividends and growth
2. Difficult to estimate cost of equity if unlisted
3. Creates zero value for zero dividend companies
What is the P/E method of valuation?
Can provide the highest business valuations
Market-based value = earnings of target x P/E ratio
Earnings are profit after tax
What are three strengths and three weaknesses of the P/E Valuation Model (DVM)?
Strengths
1. Simple and commonly used
2. Good for valuing controlling interests
3. P/E incorporates market view of growth
Weaknesses
1. Difficult to establish P/E to use
2. Difficult to establish sustainable earnings
3. Based on accounting profits, not cash flows
How would you incorporate Earnings Yield into the P/E Method?
Earnings Yield is the reciprocal of P/E
Carry out the same calculation but multiply by (1/Earnings Yield)
What are the names of the two Cash Flow Valuation Models?
- Cash flow to all investors
- Cash flow to equity
What are the four steps to the Cash Flow to all Investors method?
- Identify the cash flow to all investors (ie. before interest payment)
- Discount at WACC
- This calculates the NPV of the cash flows before allowing for interest payments
- Subtract the value of debt to be left with just the value of equity
Step 1 is: PBIT less tax and investment in assets plus depreciation and any new capital raised
What are the three steps to the Cash Flow to all equity method?
- Identify the cash flow to equity (after interest)
- Discount at an appropriate cost of equity, Ke
- This calculates the NPV of the equity
Step 1 is: PBIT less interest, tax, debt repayment, investment in assets plus depreciation and any new capital raised
What are three strengths and three weaknesses of the Cash Flow Valuation Model?
Strengths
1. Based on cash flow
2. Good for valuing a controlling interest
3. Can incorporate expected synergies
Weaknesses
1. Difficult to forecast future cash flows accurately
2. Difficult to estimate synergies that will arise
3. Calculating a discount facotr representing risk can be difficult