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Corporate Valuation Flashcards

1
Q

All equity financed firm

A
  • Value of assets
  • Value of equity

–> If a company is completely financed with equity, the value of equity equals the value of assets

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2
Q

Partially equity financed firm

A

Value of asset :
- Value of liabilities
- Value of equity

–> If a company is financed with equity and debt, the sum of the value of equity and the value of debt equals
the value of assets

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3
Q

Dividend Discount Model: main idea

A

From a stock investment (e.g., from t = 0 to t = T), a stockholder can expect to receive all future dividends (Dt) plus the price (PT) when selling the stock

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4
Q

Dividend Discount Model: calculation

A

PVo = D1/ (1 + r1) + D2/ (1+r2) + .. + DT + PT / (1+r)^T

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5
Q

The Gordon Growth Model (GGM): definition

A

a special case of the Dividend Discount Model (DDM)

The equity value is determined by dividend payments (D) to shareholders, assuming a constant dividend growth (g) and r > g

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6
Q

The Gordon Growth Model (GGM): calculation (equity value)

A

D1 / r - g

!!! use for simplicity but implies a constant dividend growth rate to infinity (or a very long period of time)

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7
Q

Gordon Growth Model – Estimating growth rates: main idea

A

If a firm pays out all its earnings, it will not grow. If the firm retains some of its earnings, these earnings will be reinvested and impact the growth rate of the firm

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8
Q

Gordon Growth Model – Estimating growth rates: main idea: calculation

A

g = ROE(return in Equity) x retained earnings

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9
Q

ROE (return in Equity): calculation

A

EPS / Book value per Share

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10
Q

Plowback ration : calculation

A

1 - Dividend / EPS

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11
Q

Present value of growth opportunities: calculation

A

Value with growth - Value without growth

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12
Q

Present value of growth opportunities: definition

A

the net present value of a firm’s future investments

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13
Q

investment opportunities have a positive NPV

A

The increase in the stock price reflects the fact that the planned investments provide an expected rate of return greater than the required rate

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14
Q

Sustainable growth rate

A

is the highest growth rate that the firm can maintain without increasing its financial leverage

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15
Q

Payout ratio: definition

A

the proportion of income which is paid out to
shareholder

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16
Q

Payout policy resolves two questions

A

1) How much cash should the corporation pay out to its shareholders?

2) How should the cash be distributed, by paying cash dividends or repurchasing shares?

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17
Q

Dividend policy: 2 types of payout ratio

A
  • High payout ratio
  • Low payout ratio
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18
Q

High payout ratio

A

High dividend yield today, but limited growth implies (relatively) lower dividend payments in the future

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18
Q

Low payout ratio

A

Low dividend yield today, but strong growth implies (relatively) higher dividend payments in the future.

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19
Q

Problems of DDM & Gordon Growth Models

A
  • young and high-growth firms often do not pay dividends
  • dividends are the strictest / narrowest measure of cash flow to equity and many firms do not pay dividends
  • more firms buy back shares to return cash to their
    shareholders
  • Concentrating on dividends would result in an erroneous valuation
20
Q

To account for stock buyback, which concept can be applied?

A

Augmented dividend

21
Q

Augmented dividend: definition

A

dividends + stock buyback

22
Q

What is the problem with buybacks in contrast to dividends?

A
  • The problem with buybacks is that in contrast to dividends, which are smoothed (because of a signaling effect), they often spike
23
Q

What are the consequences of the problems on Buybacks?

A

Buybacks should be normalized by using averages
over longer time periods (e.g., five years)

When using (augmented) dividends, we trust managers to pay out excess cash to shareholders. The large cash balances of man large firms suggest otherwise

24
Instead of using dividends in the Dividend Discount Model (DDM), free cash flows (FCF) can also be used to value a company
schema page 24
25
How to calculate the free cash flow to the firm?
potentially distributed to a firm’s creditors and shareholders, the cash flow has to be adjusted for reinvestment needs --> Any tax benefits from interest expenses are neglected
26
The reinvestments consist of two parts
1. Reinvestment in long-lived assets 2. Reinvestment in short-lived assets
27
Reinvestment in long-lived assets
Difference between capital expenditures (CAPEX) and depreciation which is not a cash expense and therefore is added back to net income
28
Reinvestment in short-lived assets
Change in non-cash working capital. Increases in inventory and accounts receivable represent cash tied up in assets that generate no return (i.e., wasting assets). Supplier credit and accounts payable mute the effect on cash flows
29
Terminal or horizon value
The final payment at H
30
To determine the horizon value PV H: what is often assumed?
free cash flows at the end of the detailed planning period grow uniformly at a constant rate g
31
horizon value: calculation
page 27
32
present value of a corporation
Pv0 = FCF1 / (1 + r) + FCF 2/ (1+r)^2 +... + FCF h/ (1+r) ^H + 1/(1+r)^H x FCF H+1/ r-g page 27
33
Advantages of the DCF method
- The DCF method considers the cash flows which were generated from business activities in one year - Amortization policy and different accounting rules have a significant influence on profits, but not on cash flows. Hence, DCF is independent from profit considerations and accounting policies - DCF is independent of dividend payments, which primarily reflect a decision on the distribution of profits
34
Potential pitfalls of the DCF method
- Transparency: What level of budgeting / amount of CAPEX has been chosen (and why)? - Often made assumption: Investments in fixed assets and working capital grow in proportion to sales - Material correctness: Are the cash flow forecasts realistic based on both the company’s profile and the economic outlook for the industry and economy at large? - Forecast annual sales usually by estimating growth rates - Forecast annual costs which should reflect the competitive environment (marketing, competitive prices, etc.)
35
Better to overcome pitfalls from the DCF method
Often it is more informative to compare the relative value (or implied growth rate) of different firms By comparing firms, market expectations can be included in the valuation
36
Multiple Valuation: Procedure
1. Determine a peer group 2. Choose one (or several) financial ratios 3. Calculate the ratios for both the firm to be compared and the peers 4. Calculate the mean or median of the peer group as a benchmark
37
Equity valuation
Often used as a second / additional valuation method Sometimes as a primary valuation method
38
Investment decisions
- Primary decision tool for style investing (i.e., value / growth investing) - Frequently used for stock screening - The aggregate of such valuation ratios is often used as a measure of market valuation and investor sentiment
39
Multiple Valuation – Important Multiples
- Price-earnings multiple (P/E) - Earnings yield (EY) or Earnings-price multiple (inverse of the P/E) - Dividend yield (D/P) - Market-to-book ratio (M/B) - Price-sales ratio (P/S) - Enterprise value-EBITDA multiple (EV/EBITDA)
40
Price-earnings multiple (P/E) : calculation
P/E = Price / Earnings
41
Earnings yield (EY) : calculation
EY = Earnings / Price
42
Dividend yield (D/P): calculation
D1/P0 = Dividend in t=1 / Price in t=0
43
Market-to-book ratio (M/B): calculation
M/B = Share price / Book value per share
44
Price-sales ratio (P/S): calculation
P/S = Share price / Annual sales per share
45
Enterprise value-EBITDA multiple (EV/EBITDA): calculation
EV/EBITDA = Entreprise value / EBITDA EV : Market value of equity + book value of debt - cash EBITDA : Earnings before interest, taxes, depreciation, and amortization
46
Multiple Valuation: Pros
- Few assumptions - Easy to calculate and interpret - Reflects current market mood (i.e., provides information on market state); comparison between firms at the same time is not affected - Allows easy comparison between firms and industries
47
Multiple Valuation: Cons
- Neglect of risk - Limited forward looking (e.g., D/P) - Bubble effect (e.g., inflated values in bull market) - Lack of transparency --> Choice of peer group --> Choice of multiples --> Calculation of multiples

Corporate Financne (5 decks)

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