Corporate Valuation Flashcards
Calculate equity value based on following information:
- EV = $234,503
- Net debt = $9,542
- Cash = $2,618
- Options/ warrant proceeds = $1,408
(General Formula) Equity Value = EV - Net debt + cash & cash equivalents
Note that equity value is found by taking the company’s FULLY DILUTED shares outstanding and multiplying it by the stock price offered in the context of M&A or market stock price. Fully diluted means that aside from just the basic shares outstanding, it includes:
- In-the-money options
- Warrants
- Convertible securities
In this case, we have the following equity value:
Equity Value = EV - Net debt + cash & cash equivalents + options and warrant proceeds
Equity Value = 234,503 - 9,542 + 2,618 + 1,408 = 228,987
Equity value is found by taking the company’s FULLY DILUTED shares outstanding and multiplying it by the stock price offered in the context of M&A or market stock price. Fully diluted means that aside from just the basic shares outstanding, it includes: choose 1-5 A) In-the-money options B) Out-of-the-money options C) Warrants D) Convertible securities E) Preferred stocks
Fully diluted means that aside from just the basic shares outstanding, it includes: choose 1-5
A) In-the-money options
C) Warrants
D) Convertible securities
NOT E) Preferred stocks are hybrid securities that have features of both equity and debt. They are treated more as debt, in this case, because they pay a fixed amount of dividends and have a higher priority in asset and earning claims than common stock. In an acquisition, they normally must be repaid just like debt.
The valuation method is used in reality for the valuation of real estate assets and holding companies (: companies devoted to investing in other companies)? A) DCF B) Multiples C) Asset-Based Methods D) LBO E) APV
Asset-Based Methods are used to compute the market value of single investments and compare this with the balance sheet values. Afterward, by deducting the financial position to calculate the market value of equity.
According to the “valuation framework as a function of uncertainty and managerial flexibility”, a risk that is characterized by low managerial flexibility and high uncertainty entail?
A) risks that are highly significant and specific. In this event, the average scenario will never materialize. Therefore, you must use two different scenario plans: either it happens or it does not happen
B) a risk that is of significant impact if materialized, but you are able to react.
C) a risk that is of insignificant impact but no managerial ability to react and improve the situation of the scenario materializes
D) none of the above
A) risks that are highly significant and specific. In this event, the average scenario will never materialize. Therefore, you must use two different scenario plans: either it happens or it does not happen.
- Example: you own a manufacturing company with 50% of revenues coming from Armani – if a license is renewed, you maintain current profit, if not, you don’t. Therefore, you use the high uncertainty scenario framework.
In the CAPM, the risk-free rate measures:
A) the market risk
B) the exposure to market risk (systematic risk)
C) time value of money
D) none of the above
In the CAPM, the risk-free rate measures: C) time value of money
R_f is the return that is required on a risk-free asset (since the investor could otherwise invest the capital in a risk-free asset). With this having theoretically no uncertainty, this part of the formula simply measures the time value of money.
Reinvestment risk is defined as:
A) the risk of the company not being able to reinvest at the same rate as estimated in DCF valuation.
B) the risk that a positive reinvestment rate (positive growth) amplifies any potential negative return of the company
C) the risk that a “risk-free” investment turns out to be not risk-free
D) the risk that an investment’s cash flows will earn less in a new security investment, creating an opportunity cost. It is the potential that the investor will be unable to reinvest cash flows at a rate comparable to their current rate of return.
Reinvestment risk is defined as: D)
the risk that an investment’s cash flows will earn less in a new security investment, creating an opportunity cost. It is the potential that the investor will be unable to reinvest cash flows at a rate comparable to their current rate of return.
Theoretically, there should be zero variance and zero standard deviation in a risk-free investment, which entails that a risk-free rate has no risk nor uncertainty. It needs to have no default risk and no reinvestment risk. Therefore, this rate should only measure the time value of money, which is a very accurate assumption of the risk-free rate in real-life valuation.
TRUE/ FALSE
FALSE: In reality, it is highly unlikely that any asset has zero volatility. Therefore, this methodology is an approach to capture reality in the best POSSIBLE way but does NOT fully represent real life.
Most of the time, the approach to incorporate the “risk-free” rate is:
A) CFs of each country of operation is to be discounted with separate discount rates, based on the risk-free rates in each individual country
B) Dominating country, based on sale: e.g., the government bond YTM in the country with dominating sale is used as the risk-free rate
C) Weighted average rate (based on % sale in each country): e.g., the weighted average of the governments’ bonds’ YTM based on % of sale in each country is used as the risk-free rate
B) Dominating country, based on sale: e.g., the government bond YTM in the country with dominating sale is used as the risk-free rate
This is the most common method used.
Under the “historical risk premium” approach, which of the following is NOT an underlying methodology?
A) CFs of each country of operation is to be discounted with separate discount rates, based on the market risk premium in each individual country, using each respective country’s market index return as (r_M).
B) Dominating country, based on % sale: the dominating country’s market index return is used as the r_M and as the basis of market risk premium calculation.
C) Weighted average return on indices (based on % sale in each country): weights based on % sales are assigned to each country’s market index return, which accumulates to a proxy for r_M used in market risk premium calculation and CAPM of the entire company
D) Implied risk premium approach: where r_M is implied in the estimates of CFs returned to all shareholders n the index (dividends and buybacks), at consensus growth
E) MRP directly estimated by Damodaran’s research
WRONG:
D) is NOT a “historical risk premium” approach, but an “Implied risk premium approach”, where r_M is implied in the estimates of CFs returned to all shareholders n the index (dividends and buybacks), at consensus growth.
E) is NOT a “historical risk premium” approach, but a different credible approach, where MRP is directly estimated by Damodaran’s research
1) The asset/stock is exactly as volatile as the market when β is _____
2) The asset/stock is more volatile than the market (the stock is procyclical) when β is _____
3) The asset/stock is less volatile than the market when β is _____
4) The asset/ stock is uncorrelated to the market when β is _____
5) The asset/stock is negatively correlated to the market when β is _____
1) The asset/stock is exactly as volatile as the market when β is EQUAL TO 1
2) The asset/stock is more volatile than the market (the stock is procyclical) when β is ABOVE 1
3) The asset/stock is less volatile than the market when β is BETWEEN 0 AND 1
4) The asset/ stock is uncorrelated to the market when β is EQUAL TO 0
5) The asset/stock is negatively correlated to the market when β is NEGATIVE
The higher amount of fixed financing cost (interest payments connected to debt financing) relative to variable financing costs (dividend payout connected to equity financing), the HIGHER/LOWER the raw (levered) beta.
The higher amount of fixed financing cost (interest payments connected to debt financing) relative to variable financing costs (dividend payout connected to equity financing), the HIGHER the raw (levered) beta.
The rationale is: the higher the proportion of fixed costs, the higher the risk for the company. The same counts for fixed and variable operating costs: The higher amount of fixed operating expenses (salaries, depreciation) than variable operating costs, the higher the beta.
Which of the following about “unlevering beta” is NOT true?
A) A common methodology applied to unlever beta is the Hamada formula
B) A common methodology applied to unlever beta is the Blume formula
C) When unlevering beta for comparable companies under the fundamentals (bottom-up) approach, we need each individual comparable comps’ levered beta, D/E ratio, and tax rate
D) the debt used in the D/E ratio may be either net debt (net cash) or gross debt - as long as the valuation is consistent in using either one
E) it is probable that some of the comparable comps have negative net D/E ratios, in which case we set the ratio to 0 (common in real life valuation).
WRONG: B) A common methodology applied to unlever beta is the Blume formula
The Blume formula is used to adjust raw beta to take into account the assumption that beta moves toward 1 - that is, putting 2/3 weight on the actual raw beta and 1/3 weight on market beta (=1)
In the context of valuation - e.g., when calculating the industry beta using the bottom-up approach, why may it be appropriate to compute the MEDIAN of the comparable comp betas, rather than AVERAGE?
MEDIAN is a good way to exclude any potential outliers, while the AVERAGE incorporates such outliers.
Which of the following statements about the risk profile of the company to be assessed by the WACC is NOT true?
A) cost of debt is always lower than the cost of equity - even when k_D embeds specific default risk
B) the beta used in cost of capital calculation excludes specific risks due to the assumption of diversification
C) firm-specific risks (non-systematic) can be incorporated directly into WACC as additional premium factors
D) WACC does not incorporate any non-systematic risks
WRONG: D) WACC does not incorporate any non-systematic risks
Damodaran has contributed to the field of valuation thought: select 1-4
A) Market risk premium estimate used in CAPM
B) Adjustment of beta to take into account that firms over time become more diversified and mature, and therefore have a beta approaching 1
C) Unlever/ reliever beta formula
D) Rating-based cost of debt estimation: if no credit rating on the target company exists, an implied rating can be derived using Damodaran’s rating model for SMEs (latest: Aug. 2021).
Damodaran has contributed to the field of valuation thought:
A) Market risk premium estimate used in CAPM &
D) Rating-based cost of debt estimation: if no credit rating on the target company exists, an implied rating can be derived using Damodaran’s rating model for SMEs.
B) Adjustment of beta to take into account that firms over time become more diversified and mature, and therefore have a beta approaching 1. This is the Blume formula
C) Unlever/ reliever beta formula is the Hamada formula
The capital structure theory helps us evaluate and understand whether a certain level of leverage creates value.
TRUE/ FALSE
TRUE
When computing a DCF of a company with NO growth and WITH Taxes, which of the following characteristics is/are TRUE? select 1-5
A) the perpetuity formula is used to make the DCF computation:
DCF = (CF_(Annual Constant)) / WACC
B) growth rate, g=0
C) income and cash flows can be assumed constant and perpetual
D) any investments made are only for maintenance. There is no change in working capital or CAPEX.
E) leverage increases EV, because interest expenses are tax-deductible.
All of the statements are TRUE
If a company has no debt, following is TRUE: Select 1-4
A) the company’s FCFE = FCFO
B) the company’s EV (market value of capital employed) = Equity Value
C) the required return to equity-holders is the cost of unlevered equity
D) cost of unlevered equity estimated by using CAPM is:
k_EU = r_F + β_U * (r_M-r_F)
E) all of the above are true
E) all of the above are true
A) the company’s FCFE = FCFO –> FCFE = FCFO - interest expense + tax shield. In the absence of debt, interest is 0 and so is the tax shield.
B) the company’s EV (market value of capital employed) = Equity Value. If the company was financed by any debt, the EV would be equal to equity value + net debt (debt-cash) –> EV would be higher than equity value
C) the required return to equity-holders is the cost of unlevered equity - same rational as WACC : but now there is no debt nor any tax shield or cost of debt
D) cost of unlevered equity estimated by using CAPM is:
k_EU = r_F + β_U * (r_M-r_F)
- unlevered cost of equity uses unlevered beta!
With no debt, Equity Value = EV. According to Modigliani and Miller, as debt increases, EV _____ relative to equity value
A) increases
B) decreases
With no debt, Equity Value = EV. According to Modigliani and Miller, as debt increases, EV INCREASES relative to equity value.
MM2 argues that as debt increases, the cost of equity levered increases too. Why is that?
Cost of equity levered increases as the debt of the company increases, because debt increases risk of the firm (default risk), which in turn leads to higher required return by equiyt investors.
In case of the Classical model, as leverage increases, WACC decreases, despite that cost of equity will rise with the increased risk. The decreased WACC is the standard result, reflecting the advantages to debt provided by the tax system (interest is deductible).
TRUE/ FALSE
TRUE
In the generalized asset-side DCF model with growht, which of the following statements are TRUE? Select 1-4
A) Under a real-life scenario, the steady state hypotheses are relaxed, and the valuation is generally split into two parts: business plan and terminal value - it is a two-staged model
B) Business plan: the explicit part, where FCFO will depend on the company’s business plan for a few first explicit years, which are independently discounted.
C) Terminal value: the synthetic part, where the years beyond will be valued through a synthetic terminal value, under a steady growth equilibrium scenario.
D) WACC is (usually) constant across all periods
All four statements are correct
In the steady state scenario at the end of the business plan horizon (where TV is computed), which of the following characteristics apply? Select 1-4
A) CAPEX = DD&A: investments are only made to the maintenance of already existing assets. No reinvestments are made beyond those made for maintenance
B) Given NO growth, the change in NWC = zero or NWC is growing at the steady growth rate (generally the inflation rate)
C) No change in gross debt
D) Gross debt will typically decrease
All are characteristics of a steady state scenario where TV is computed from, EXCEPT D.
Positive growth is always enterprise value enhancing.
TRUE/ FALSE
FALSE
Growth rate does translate into enhanced enterprise value, provided that the return of the growth rate is higher than the cost of capital.
If the cost of capital (WACC) > ROI, growht ______ the enterprise value
If the cost of capital (WACC) < ROI, growth ______ the enterprise value
If the cost of capital (WACC) =ROI, growth ______the enterprise value
Plug in the right places: increases, decreases, is irrelevant for the
If the cost of capital (WACC) > ROI, growht DECREASES the enterprise value
If the cost of capital (WACC) < ROI, growth INCREASES the enterprise value
If the cost of capital (WACC) =ROI, growth IS IRRELEVANT the enterprise value
In restated financial statements (finanicals for valuation purpose), operating, financing and surplus activities should be shown separately. Match the mentioned categories to the following descriptions:
____ refers to the daily tasks of a company: buying/ selling goods, investing, etc. These activities are those that are needed to run the business.
____ refers to raising and repaying debt and equity. These are funding-related activities.
____ include redundant assets that are not necessary to the daily business activities, e.g., renting out unused property. These are also called the non-operating activities.
OPERATING ACTIVITIES refers to the daily tasks of a company: buying/ selling goods, investing, etc. These activities are those that are needed to run the business.
FINANCING ACTIVITIES refers to raising and repaying debt and equity. These are funding-related activities.
SURPLUS ACTIVITIES include redundant assets that are not necessary to the daily business activities, e.g., renting out unused property. These are also called the non-operating activities.
The rationale for reorganization of financial statements is to show the most meaningful metrics that support cashflow calculations and therefore allows us to execute a more accurate valuation.
TRUE/ FALSE
TRUE
A contingent liability is when the firm has evaluated that in the years to come, an event will very likely happen, which will result in a cash outflow of a certain amount. From an accrual base, this amount must be recorded as an expense. What is this contingent liability referred to as?
A risk provision (liability)
In a restated balance sheet; tangible assets, intangible assets (patents, brand, etc.), capitalized leasing assets and goodwill are all categorized under which underlying category of capital employed (assets)?
A) Noncash (non-debt) working capital
B) Fixed assets
C) Surplus assets & liabilities
B) Fixed assets: basically, it is equivalent to the non-operating assets in the as-reported balance sheet. These are the assets employed to run the business for a longer period of time. Usually, there is no liabilities associated with these assets.
This category Incl. tangible assets, intangible (patents, brands…), capitalized leasing assets, goodwill.
Which of the following statements are NOT TRUE about non-cash (net) working capital (a subcategory of capital employed in restated balance sheet):
A) NWC represents the outstanding assets net outstanding liabilities that are necessary to perform the ordinary daily activities in the business cycle.
B) NWC is is calculated as the amount of outstanding assets less amount of outstanding liabilities from daily activities
C) The higher NWC, the better liquidity of the company
D) Typically, the firms in the supermarket sector have low or negative NWC
WRONG: C) The higher NWC, the better liquidity of the company
A lower the NWC is better, since it means that all equal, the firm is are getting its return with less cash employed - it reflects that the firm is better at getting cash inflows from its receivables fast, and/or has longer time to pay its payables - which accumulates to better liquidity and cash flow management.
NWC can also be negative (e.g., in the supermarket sector: no trade receivables and huge market power compared to suppliers; therefore long maturity before payable must be paid).
A low working capital is often associated with a very low net debt = better for the firm.
Surplus assets and liabilities are non-essential to the business’ core operations. Which of the following would DEFINITELY NOT be classified as a surplus asset/liability in the restated balance sheet? Choose 1-7
A) the firm’s ownership of shares of other firms (must be non-controlling: <50%) or “interests in associates”
B) pension liabilities (employee servance)
C) financial assets/ investments: “financial receivables”
D) other non-current assets: in this case illiquid and non-marketable
E) exceptional provisions: a substantial gain/ loss that is unlikely to repeat itself in the future
F) property of business operation
G) assets and liabilities held for sale: e.g., old production equipment no longer useful to the firm’s business operation
F) property = fixed asset, since it is crucial to the daily operation of the firm.
All the other items are considered surplus assets in restate balance sheet.
The “financing sources”/ financing activities category in a restated balance sheet includes net debt and equity. Are the following statements true?
A) net debt includes interest-bearing loans and bonds, convertible securities, financial leasing debt, etc. These items are easily identifiable and distinguishable from short-term account payables due to the presence of interest expenses. It is called net debt because it is the amount net the excess cash and cash equivalents.
B) equity stated in the as-reported BS is equivalent to equity in the restated BS. The equity category includes share capital, reserves, and minority interest.
YES - both statements are true
Deferred tax asset/liability in the as-reported balance sheet is USUALLY categorized as \_\_\_\_ in the restated B/S A) non-cash working capital B) fixed assets/ liabilities C) surplus asset D) equity E) net debt
A) non-cash working capital
Deferred tax assets: usually, tax-related assets and liabilities are considered working capital. Exceptions may occur if the tax asset is significant and occurring due to a non-normal event (e.g., covid-19), where it may be treated as a surplus asset.
Non-marketable and illiquid "non-current assets" in the as-reported balance sheet should be categorized as \_\_\_\_ in the restated B/S A) non-cash working capital B) fixed assets/ liabilities C) surplus asset D) equity E) net debt
What if they were liquid and marketable?
C) surplus asset: provided that the non-current asset is illiquid and non-marketable.
If it instead the non-current assets were liquid and marketable, it would have been categorized under cash and equivalents, which is incorporated as a deduction in “Net Debt” (-).
In multiples valuation, the numerator should always be the most updated price (market cap or EV) possible. However, the denominator can be either (i) actual/historical, (ii) forward, or (iii) trailing.
Which of the following descriptions does NOT fit the forward multiple description?
A) From a theoretical perspective, this time fra is more correct, because the current actual price (market cap) is based on expected results, which means that the nominator and denominator would be more comparable if the denominator also is forward-looking.
B) uses the current (most recent) market cap or EV as nominator and the last historically reported value driver as the denominator
C) The problem is, however, that such estimates are not always available nor necessarily correct since they are based on assumption about the future.
WRONG B) uses the current (most recent) market cap or EV as nominator and the last historically reported value driver as the denominator - this is a historical/ actual multiple.
Forward multiples: uses curret market cap or EV as nominator and forward (estimated) value driver in the denominator
It is important to be consistent when using multiples of different time frames (current/ forward/ trailing). E.g., when using actual/historical EV/EBITDA multiple, you must use historical/actual EBITDA of the firm under evaluation. Consistently, if you use forward multiples (e.g., P/E), you must use forward (estimated) net income of the company under evaluation.
TRUE/ FALSE
TRUE
In the following statements, choose the options that are highlighted with /:
- High growth firms will have HIGHER/LOWER P/E multiple provided that the return on equity is higher than the cost of equity. If this is not the case, the multiple will be impacted POSITIVELY/NEGATIVELY by growth.
- High risk firms will have a HIGHER/LOWER P/E
- Firms with lower reinvestment needs (as inversely measured by the payout ratio) will have a HIGHER/LOWER P/E ratio
- High growth firms will have HIGHER P/E ratio provided that the return on equity is higher than the cost of equity. If this is not the case, the multiple will be impacted NEGATIVELY by growth.
- High risk firms will have a LOWER P/E ratios - the ratio is inversely correlated to risk.
- Firms with lower reinvestment needs (as inversely measured by the payout ratio) will have a HIGHER P/E ratio - the ratio is inversely correlated with reinvestment needs because it decreases the payout ratio to investors
The P/E is much more sensitive to changes in expected growth rates when interest rates are low.
TRUE/ FALSE
TRUE - see graph page 61 in CV lecture notes - this you should just remember by hard
Which of the following is NOT true about the P/BV multiple? Choose 0-6
A) The P/BV multiple is less used, since it does not link directly to profitability
B) The P/BV multiple is useful when valuing a firm with negative earnings
C) Book values can vary across firms with different accounting standards, posing a disadvantage to this multiple
D) The P/BV multiple is influenced by the cost of equity: the higher the cost of equity, the lower the P/BV multiple
E) Book values can be negative after several years of negative profits, posing a disadvantage to this multiple
F) The P/BV multiple is strongly influenced by the return on equity (ROE)
All of the statements are correct about the P/BV multiple
EV/sales is a multiple that: (choose 0-8)
A) is mostly used in industries where we can assume a fixed cost structure (such as fashion industries)
B) takes into account a company’s profitability
C) allows to directly asses the market value of shareholder’s equity
D) is appropriate for mature businesses
E) is appropriate for banks
F) can be used for firms with negative earnings
G) less impacted by accounting standards
H) can lead to high multiples even for firms that are generating losses
EV/sales is a multiple that:
A) is mostly used in industries where we can assume a fixed cost structure (such as fashion industries) - that is because the multiple does not take into account the company’s profitability - which means that if cost structures in an industry were very variable - it would be difficult to compare firms.
D) is appropriate for mature businesses
F) can be used for firms with negative earnings
G) (sales or revenue) is less impacted by accounting standards
H) can lead to high multiples even for firms that are generating losses - recall, it is not linked to profitability but sales
The EV/EBITDA multiple is frequently used because: select 0-5
A) there is a strong link between EBITDA and cash flows, which is of interest to investors
B) only very few (very distressed) firms show negative EBITDA, which makes the valuation process easier
C) it is unaffected by different depreciation policies
D) Frequently, potential acquirers consider an EV multiple because debt will be refinanced after a takeover
E) It can be compared more easily among firms with different leverage
All are true
The Relationship between P/E in a Steady State and Leverage is that:
as D/E (leverage) increaes, the P/E multiple INCREASES/DECREASES
As leverage increases, the P/E DECREASES. This is because leverage increases risk, which increase the cost of equity levered (required return for investors). So, since the price is equal to: 1/k_EL in a steady state scenario (no growth), leverage decreases the P/E multiple.
(See graphs on pp. 67 in CV lecture notes)
Increasing the average dimension of a company by acquiring competitors in order to obtain higher margins, profitability, and to exploit economies of scale and scope etc. is called: A) Market consolidation B) Vertical integration C) Conglomerate consolidation D) Leveraged finance E) Industry consolidation
A) Market consolidation
When companies try to exploit improved profitability (higher economies of scale/scope) through the acquisition/merger of companies in the same industry that make products required at different stages of the supply chain (either upstream or downstream) is called: A) Market consolidation B) Vertical integration C) Conglomerate consolidation D) Leveraged finance E) Industry consolidation
B) Vertical integration
