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CFA Level 2 > Equity > Flashcards

Equity Flashcards

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0
Q

Holding period return

A

(Ending price - beginning price + CF)/(beginning price)

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1
Q

Porter’s five forces

A
  1. Threat of new entrants
  2. Threat of substitutes
  3. Bargaining power of buyers
  4. Bargaining power of suppliers
  5. Rivalry among existing competitors
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2
Q

If expected return > required return, then the asset is _____

A

Undervalued

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3
Q

Equity risk premium

A

Required return on equity index - risk free rate

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4
Q

Required return for a stock

A

Risk free rate + β*(equity risk premium)

β = adjustment for systematic risk of the stock

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5
Q

Ibbotson-Chen supply-side estimate of equity risk premium

A

(1+expected inflation)(1+expected real GDP growth)(1+expected changes in P/E ratio) - 1 + expected yield on the index - risk free rate

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6
Q

Fama-French model

A

RF + βm(market risk premium) + βs(small cap return - large cap return) + βb*(high book to market return - low book to market return)

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7
Q

Pastor-Stambaugh model

A

Add liquidity premium to Fama French model

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8
Q

Build-up method

A

RF + equity risk premium + size premium + industry risk premium + specific company premium

Best for closely held companies

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9
Q

How to unlever β

A

= levered β *(1/(1+D/E))

= levered β *(E/A)

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10
Q

WACC

A

[(MV of debt)/(MV of debt + equity)](required return on debt)(1-t) + [(MV of equity)/(MV of debt + equity)]*(required return on equity)

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11
Q

When to use dividend discount model

A
  • Firm has a history of dividends
  • Dividend policy is clear and tied to earnings
  • Perspective of minority shareholder
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12
Q

When to use free cash flow model

A
  • For firms with no dividend history or dividends have not been clearly tied to earnings
  • For firms with free cash flow that correspond with profitability
  • Perspective is as controlling shareholder
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13
Q

When to use residual income model

A
  • Firm does not have dividend history or volatile payment stream
  • Negative free cash flows for the foreseeable future
  • Uncertain terminal value
  • Firm with transparent financial reporting and high quality earnings
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14
Q

Gordon growth model

A

Assumes dividends increase at a constant rate indefinitely

D1/(r-g) or D0*(1+g)/(r-g)

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15
Q

PVGO (present value of growth opportunities)

A

Value of the firm - (no-growth earnings)/(required return on equity)

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16
Q

Justified leading P/E

A

P0/E1 = (1-b)/(r-g)
= D1/[E1*(r-g)]

where b=retention rate

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17
Q

Justified trailing P/E

A

P0/E0 = [(1-b)(1+g)]/(r-g)
= D0(1+g)/[E0*(r-g)]

where b=retention rate

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18
Q

Sustainable growth rate

A

Firm’s growth rate with current D/E ratio (using internally generated funds)

retention ratio*ROE

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19
Q

Long-term growth rate

A

PRAT
Profit marginretention rateasset turnover*financial leverage

[(NI-div)/NI] x (NI/sales) x (sales/total assets) x (total assets/total stockholders’ equity)

20
Q

Rate to discount FCFF for firm value

A

WACC

21
Q

Rate to discount FCFE for equity value

A

Required return on equity

22
Q

Free cash flow to the firm (FCFF)

A

= NI + NCC - WCInv + Int(1-t) - FCInv + pref div
= CFO + Int(1-t) - FCInv + pref div
= EBIT(1-t) + Dep - FCInv - WCInv + pref div

NCC = non-cash charges
FCInv = change in fixed capital assets (CapEx)
= end gross PP&E - beg gross PP&E - gain on sale
WCInv = change in working capital (excluding cash)

23
Q

Free cash flow to equity

A

= FCFF - Int(1-t) + net borrowing - pref div + net issuance of pref stock

= NI + NCC - FCInv - WCInv + net borrowing - pref div + net issuance of pref stock

24
Q

Compare dividend discount models to free cash flow models

A

DDM - from minority shareholder perspective

FCFF - from controlling perspective

25
Q

Types of FCFF models

A

Single stage model: similar to DDM, use WACC for firm value and required return on equity for equity value

Two stage model w/declining growth: apply proportionate discount rates corresponding CFs

26
Q

Molodovsky effect

A

High P/E at bottom of business cycle due to low EPS and low P/E at top of business cycle due to high EPS

27
Q

Justified P/B

A

(ROE-g)/(r-g)

28
Q

Justified P/S

A

= (E0/S0)[(1-b)(1+g)]/(r-g)

= net profit margin * justified trailing P/E

29
Q

Enterprise value

A

MV of common stock + MV of preferred stock + MV of debt + minority interest - cash and investments

30
Q

Residual income

A

Net income - equity charge

31
Q

Economic value added

A

EBIT*(1-t) - $WACC

Valued added for shareholders during the year

32
Q

Valuing a firm with the residual income model

A

= BV0 + PV of expected future residual income
= BV0 + [(ROE-r)*BV0]/(r-g)
= BV0 + (PV of high growth RI) + (PV of continuing RI)

33
Q

Forecasting residual income

A

= expected EPS in year t - (r* book value of equity in year t-1)
= (expected ROE - r)*book value of equity in year t-1

34
Q

Valuing a private company with constant growth

A

(FCFF1)/(WACC-g)

35
Q

Valuing a private firm with significant intangible assets

A

Excess earnings method

36
Q

Guideline public company method

A

Use price multiples from trade data for public companies and adjust for differences (add control premium)

37
Q

Guideline transactions method

A

Use acquisition values from historical transactions for entire companies (no additional control premium needed)

38
Q

Prior transaction method

A

Use transaction data for the stock of the actual subject company (best for valuing noncontrolling interests)

39
Q

Discount for lack of control (DLOC)

A

1-1/(1+control premium)

Use to value noncontrolling interest based on data for controlling interest

40
Q

Discount for lack of marketability

A

1 - [(1-DLOC)(1-DLOM)]

41
Q

Trailing dividend yield

A

(4 x most recent quarterly dividend)/market price per share

42
Q

Leading dividend yield

A

forecasted dividends for next 4 quarters / market price per share

43
Q

Strategic styles for industries

A

Adaptive - less malleable, less predictable
Shaping - more malleable, less predictable
Classical - less malleable, more predictable
Visionary - more malleable, more predictable

44
Q

ROIC

A

NOPLAT/Invested capital

NOPLAT: net operating profit less adj taxes
Invested capital: op assets - op liabilities

45
Q

ROCE (return on capital employed)

A

Operating profit/capital employed

Capital employed: debt capital + equity capital

Pretax measure of profitability of capital

46
Q

Equity method

A
  • Report proportionate share of income on income statement

- Report carrying value of proportionate share of income less dividends received

47
Q

H-model

A

[D0(1+gL) + D0(H)(gS - gL)]/(r-gL)

48
Q

Two stage model

A

Σ[D0(1+gS)^t]/(1+r)^t + [D0(1+gL)(1+gS)^n]/[(r-gL)(1+r)^n]

CFA Level 2 (9 decks)

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