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Financial Accounting > Corporate Valuation > Flashcards

Corporate Valuation Flashcards

1
Q

Value or Theoretical Price

A

Sum of discounted expected future cash flows

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2
Q

Corporate Valuation Approach

A

Substance Valuation
Discounted Flows
Valuation Multiples

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3
Q

Substance Valuation

A

Assets - Liabilities = SE

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4
Q

Pros and cons of substance valuation

A

Pros:
Simple - little input and easy to calc
Easy to communicated
good link to dcf models

Cons:
Insufficient for companies where balance sheet doesn’t show the full picture

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5
Q

Discounted flows approach

A

Make a detailed scenario a few years ahead and calculate the terminal value

  • Dividends
  • Residual Income
  • Free cash flows
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6
Q

Pros and cons of Discounted flows approach

A

Pros:
can capture detailed scenarios
shows value drivers
Shows assumptions

Cons:
A lot of work
difficult to make forecasts
high risks for mistakes

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7
Q

Multiple Valuation Approach

A

P/E Multiples -> make use of comp firms

Other multiple: EV/EBIT etc

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8
Q

Pros and Cons of multiple approach

A

Pros:
Simple easy to input and calculate
Easy to communicate
eaily applied to PE firms

Cons:
difficult to find comps
- Hard for high growth /profitability firms
-> how do u know if its valued properly

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9
Q

Indirect Equity Valuation

A
  • Focus on flows from operations.
  • Estimate the value of the company’s operations: V(CE).
  • Estimate the value of the company’s debt: V(D).

V(CE) − V(D) = V(E)

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10
Q

Direct Equity Valuation

A
  • Focus on flows to stock owners.

- Estimate value of the company’s equity: V(E).

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11
Q

Discounted Dividends

A

Direct valuation of Shareholder’s equity

The required rate of return for shareholders equity rE

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12
Q

DCF

A

Indirect valuation of shareholders equity

Requited rate of return for operating net assets rW ACC

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13
Q

Book value of equity + discounted residual income RI

A

Direct valuation

Required rate of return for shareholders equity rE

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14
Q

Present value formula

A

PV= FV \ (1+r)^t

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15
Q

Present Values Annuity

A

An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income stream for retirees.

PV = (E[CF] / r ) x (1 − 1 /(1 + r)^T)

E(CF) = each annuity payment
T = number of periods 
r = interest rate / discount rat e
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16
Q

Present Value Perpetuity

A

PV = E(CF) / r
if growth
PV = FV / (r-g)

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17
Q

Required rate of return

A

rF + Compensation for risk

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18
Q

Rf

A

Nominal risk free interest rate
= treasury bond yield - inflation
= real risk free interest rate + expected inflation rate premium

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19
Q

Re

A

Required rate of return on equity
or expected total return of shareholders
= Rf + risk premium
= Risk-Free Rate of Return + Beta × (Market Rate of Return – Risk-Free Rate of Return)

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20
Q

Cash flows shareholders can obtain from owning stock

A

Dividends and Capital Gains

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21
Q

Explain rE formula

A

The expected total return of a shareholder is equal to the expected retrn of other investments available in the market with equivalent risk

The firm must pay SHs a return equivalent for the return they can earn elsewhere

22
Q

Dividend Discount Model concept

A

The value of equity or theoretical current price (P0) is equal to the present value of the expected future dividends it will pay.

23
Q

DDM with perpetual growth

A

PV of future dividendds = Price per share = D/ r-g
D = estimated value of next years dividends per share
r = cost of capital equity
g= constant growth rate for dividends

24
Q

DDM When is a stock undervalued

A

When the PV of future dividends > current market value of the stock

25
Q

Divt as a function of eps

A

Earnings/Shares outstanding x payout ratio

Div t = EPSt x Payout Ratiot

26
Q

relationship between retention, plowback, and payout ratio

A

retention ratio = plowback ratio = 1- payout ratio

27
Q

DDM growth formula at steady state

A 
gss = ROE x Plowback ratio 
gss = ROE x (1 - payout ratio)
28
Q

Plowback ratio

A

=(Net income - dividends) // Net income

29
Q

Dividends under clean surplus

A

Div1 = E0 x ROE x payout ratio

30
Q

DDM Terminal value

A

(Divf + 1) / (rE-g)

/ (1+rE)^F

31
Q

Multiple Ratios

A

Market based measure / Accounting based measure

32
Q

Forward P/E

A

when you buy a stock, you are buying the rights to the firms future earnings
= P0 / EPS1
= Div1/EPS1 / (rE - g)
= Payout ratio / (rE - g)

33
Q

Trailing P/E

A

P0/EPS0

34
Q

Pros of DDM

A
  • Theoretically justified (dividends are cash flows to shareholders).
  • Less volatile than other measures (if a firm stops paying dividends it can be a very bad signal).
  • Closely connected to growth financials and easy to use on the basis of accounting data.
35
Q

Cons of DDM

A
  • Not all firms pay dividends.
  • Expectation of future dividends bears uncertainty.
  • Puts more weight on the steady state.
  • Takes the perspective of a minority investor who cannot control the dividend policy (say on dividend).
36
Q

Pros of multiples advantage

A
  • easy to use and apply

- makes less assumption than other models

37
Q

Cons of multiples

A
  • Relies on comparable groups
  • If the market is efficient for the comparable companies, why is it not for our target company?
  • Interpretations of very “high” multiples can lead to ambiguous conclusions.
38
Q

Market to book ratio

A
  • approximation of growth oppertunities of a company
  • Indicates short and long term profitability and the prudence of how valuable a stock is

=Mk Val E / Book Val E
= 1 + (ROEss - rE)/(rE - gss)

39
Q

Permanent Measurement Bias

A

Book value of equity is underestimated and less than theoretical value of equity (V) based on accounting rules so the accounting long run ROE will be greater than actual rE
qT=Vt / Et - 1

40
Q

PMB ROE Formula

A

ROEss = rE + qT ×(rE −gss)

41
Q

Steady state ROE

A

rE + qt x (rE - gss)

42
Q

Residual Income Valuation model

A
  • Expresses the future cash flows to equity in terms of accounting measures of capital (e.g., book value of equity) and performance (e.g., return on equity).
  • Residual income is the income a company generates after accounting for the cost of capital.
  • Substituting future dividend payments for future residual earnings.
  • looks at the economic profitability of a firm rather than just its accounting profitability.
43
Q

Residual Income Formulas

A

Residual Income
= NI - Charge For Equity
= Net Income - (Equity(t-1) * Cost of Equity)
= (ROEt−rE)×Et−1

44
Q

Equity Growth for residual income

A

= ROE - % of equity paid in dividend

45
Q

RIV formulas

A

V0 =E0 + {NIt −rE * Et−1 / (1 + rE)^t}
=E0 + {RIt /(1 + rE )t}
=E0 + {(ROEt −rE) ×Et−1 /
(1 + rE)^t}

46
Q

Factors that can influence residual income

A
  1. Competitive advantage in product markets.
  2. Management efficiencies (e.g., Profit Margin, Asset Turnover).
  3. Efficiency of financial decisions (e.g., Gain in ROE from financial
    leverage) .
47
Q

RIV Steady State

A

Vo

= Eo + [(ROEss – rE) x Eo] / [rE – Gss)

48
Q

Steady State Payout Ratio

A

1 - gss/ROEss

49
Q

Pros of RIV

A

▶ Puts less weight on the terminal value.
▶ Uses available accounting data.
▶ Is useful for firms without or unpredictable free cash flows.

50
Q

Cons of RIV

A

▶ Relies on the clean surplus relation.

▶ May require adjustments of accounting data.

51
Q

Book Value of Equity

A

book value of equity = total equity – non-controlling interests

Financial Accounting (5 decks)

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