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Equity Valuation > Discounted Dividend Valuation > Flashcards

Discounted Dividend Valuation Flashcards

1
Q

What is discounted cash flows?

A
  • calculates intrinsic value of company’s common stock as present value of expected future cash flows
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2
Q

What are the 4 broad steps in DCF analysis are:

A
  • Defining cash flows
  • Forecasting cash flows
  • Choosing a discount rate methodology
  • Estimating a discount rate
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3
Q

What is present value of future cash flows formula?

A

PV = (CFC/ (1+r)^t) + (CF/ (1+r)^t)

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4
Q

What are 3 streams of cash flows that the discounted cash flow model can be used?

A
  • dividends
  • free cash flows
  • residual income
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5
Q

What 3 conditions met would make it most appropriate to use dividend discount model?

A
  • company is paying dividends.
  • dividend policy is consistent with the company’s profitability.
  • investor has a non-control perspective.
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6
Q

What are the 3 types of free cash flow methods you can use in discounted cash flow method?

A
  • cash flow from operations (CFO): cash generated from day to day activities
  • free cash flow to firm (FCFF): cash flows available to all capital providers
  • free cash flow to equity (FCFE): cash flow available to shareholders only
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7
Q

What 4 conditions met would make it most appropriate to use free cash flow discount model?

A
  • company is not dividend-paying.
  • company pays dividends that are materially different from the FCFE.
  • projected free cash flows are aligned with the company’s profitability.
  • investor has a control perspective (or views the company as a likely merger target).
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8
Q

What 2 conditions met would make it most appropriate to use residual income discount model?

A
  • company is not paying dividends (used as an alternative to the free cash flow model).
  • company has negative expected free cash flows.
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9
Q

What is the formula for dividend discount model for a single period and multiple periods?

A
  • single period: V0 = (D1 + P1/ (1+r)^1)
  • multi period: V0 = (D1 / (1+r)^1) + (D2 / (1+r)^2) + (P2 / (1+r)^2)

V0 = present value
D1 = dividend in one year
P1 & P2 = selling price
r = discount rate
D2 = dividend in two years

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10
Q

What is the dividend discount formula if dividends are assumed to be paid indefinitely?

A

V0 = Dt / (1+r)^t

V0 = present value
Dt = infinite dividend
r = discount rate
t = years or time

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11
Q

What does the Gordon growth model assume and what is the formula?

A
  • assumes dividend will grow at constant rate forever

V0 = (D0 (1+g) / r - g) which is also equivalent to D1/ r - g

D0 = dividend at time 0 or now
g = growth rate
r = required rate of return
D1 = dividend in 1 year

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12
Q

What is share repurchase?

A
  • when a company buys back its own shares from the market place
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13
Q

What is the implied dividend growth rate?

A
  • determining growth rate of dividend if market price is available
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14
Q

The value of a stock is the sum of what 2 following? What is the formula?

A
  • value of the company without earnings reinvestment
  • the present value of growth opportunities (PVGO)

V0 = E1/r +PVGO

V0 = present value
E1 = earnings per share in 1 year
r = discount rate
PVGO = present value of growth opportunities

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15
Q

What is the formula for P/E derived from the value of a stock sum formula (present value of growth opportunities?

A

P0 /E1 = 1/r + PVGO/E1

P0 = present value price
E1 = earnings in 1 year
r = discount rate
PVGO = present value of growth opportunities

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16
Q

What is the formula for leading P/E ratio and trailing P/E ratio?

A

leading P/E ratio = P0/E1 = ((D1/E1) / (r-g)) = ((1-b) / (r-g))

trailing P/E ratio = P0/E0 = ((D0 (1+g))/ E0) /r-g = ((1+g)*(1-b)) / r-g

P0 = price now or present value
E1 = earnings per share in 1 year
D1 = dividend in 1 year
r = discount rate
g = growth
b = retention rate
1-b = dividend payout ratio
E0 = earnings per share now
D0 = dividend now

17
Q

What is the formula that can be derived from the Gordon growth model to get stocks required rate of return?

A

r = (D1/P0) +g

r = required rate of return or discount rate
D1 = dividend in 1 year
P0 = price now or present value
g = dividend growth rate

18
Q

What are 3 stages that growth usually falls into?

A
  • growth phase
  • transition phase
  • mature phase
19
Q

What is the formula for 2 stage Gordon growth model?

A

V0 = ((D0 (1+gs)^t)/ (1+r)^t) + (Vn / (1+r)^n)

V0 = value now or present value
D0 = dividend now
gs = short term dividend growth rate
t = time
r = discount rate
Vn = terminal value of second stage of Gordon growth model
N = time

20
Q

What is the formula for terminal value derived from 2 stage Gordon growth model?

A

Vn = ((D0 (1+gs)^n)* (1+gl)) / (r - gl)

Vn = terminal value
D0 = dividend now at time 0
gs = short term dividend growth rate
gl = long term dividend growth rate
r = discount rate
n = time

21
Q

What is the formula for present value of stock for a company that doesn’t pay dividends until a later date?

A

V0 = D / (((1 + r)^n) * (r-g))

V0 = present value
D = dividend when they start paying dividends in the future
r = discount rate
n = years or time until they pay dividend
g = dividend growth rate

22
Q

What is the difference in assumption from the 2 stages Gordon growth model and the h model?

A
  • Gordon growth model: assumes high growth for a period the normal growth thereafter, which can result in very abrupt change in growth rate
  • h model: overcomes abrupt change in growth rate by smoothing transition from short term growth rate to long term growth rate
23
Q

What is the formula for h model?

A

V0 = (D0 (1+gl)) + ((D0*H) * (gs -gl)) / (r -gl)

V0 = present value
D0 = dividend now
gl = dividend growth rate long term
H = period of high growth divided by half
gs = dividend growth rate short term
r = discount rate

24
Q

What is formula of sustainable growth rate with retention ratio and ROE?

A

g = b * ROE

g = growth rate
b = retention rate
ROE = return on equity

25
Q

What is the formula for ROE using DuPoint three way analysis?

A

ROE = net income/sales * sales/total assets * total assets/shareholders equity

net income/sales = retention rate
sales/total assets = asset turnover
total assets/shareholders equity = financial leverage

26
Q

What is formula of sustainable growth rate using the PRAT method?

A

g = (net income - dividends /net income) * (net income/sales) * (sales/total assets) * (total assets/shareholders equity)

net income - dividends/ net income = profit margin (P)
net income/sales = retention rate (R)
sales/total assets = asset turnover (A)
total assets/shareholders equity = financial leverage (T)

Equity Valuation (6 decks)

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