Equity

Question 1

Gordan growth model equity risk premium

Answer 1

1 yr forecasted div yield on market index + consensus long term earnings growth rate - long term government bond yield

Question 2

Paster-Stambaugh model

Answer 2

adds liquidy factor to the fama-french model

Question 3

Blume Adjustments

Answer 3

adjusted beta = (2/3 x raw beta) + (1/3 x 1)

Question 4

Use DCF modles when

Answer 4

1. Firm has dividend history
2. Dividend policy is related to earnings
3. Minority shareholder perspective

Question 5

Use FCF models when

Answer 5

1. Firm lacks table dividend policy
2. Dividend policy not related to earnings
3. FCF is related to profitability

Question 6

Use RI model when

Answer 6

1. Firm lacks dividend history
2. Expected FCF is negative
3. Firm has transparent financial reporting and high quality earnings

Question 7

GGM

Answer 7

Assumes perpetutal D growth rate

Vo= D1/(r-g)

Question 8

Limitations to GGM

Answer 8

Very sensitive to estimates of r and g
difficult with non dividend stocks
difficult with unpredictable growth patterns (use multi-stage)

Question 9

Present Value of Growth Opportunities

Answer 9

Vo= E1/r + PVGO

Question 10

H - Model

Answer 10

Vo= [Do *( 1+gl)]/(r-gl) + [Do * H *(gs-gl)]/( r-gl)

Question 11

SGR

Answer 11

SGR= earnings retention rate x ROE

Question 12

Solving for required return

Answer 12

r = D1/Po + g

Question 13

FCFF -NI - Assuming depreciation is the only NCC

Answer 13

FCFF= NI + Dep + Int *(1-tax) - FCinv - WCinv

Question 14

FCFF -EBIT - Assuming depreciation is the only NCC

Answer 14

FCFF= EBIT *(1-tax rate) + Dep - FCinv - WCinv

Question 15

FCFF -EBITDA - Assuming depreciation is the only NCC

Answer 15

FCFF= EBITDA (1-tax rate) + Deptax rate - FCinv - WCinv

Question 16

FCFF -CFO - Assuming depreciation is the only NCC

Answer 16

FCFF = CFO + [int * (1-tax)] - FCInv

Question 17

FCFE - from FCFF

Answer 17

FCFE = FCFF - Int *(1-tax) + Net borrowing

Question 18

FCFE - from NI

Answer 18

FCFE = NI + Dep - FCInv - WCInv + Net borrwing

Question 19

Single State FCFF

Answer 19

Vo= FCFF1/ (wacc - g)

Question 20

Single stage FCFE

Answer 20

Vo = FCFE1/ (r-g)

Question 21

Problems with P/E

Answer 21

• if earnings are less than 0 PE is meaningless
• volatile, transitory portion of earnings makes interpretation difficult
• Management discretion over accounting choices

Question 22

Justified leading P/E

Answer 22

= payout ratio/(r-g)
= (D1/E1) / (r- g)
= P0/E1

Question 23

Justified trailing P/E

Answer 23

=payout ratio * (1+g)/ (r-g)
= (D1/E0) / (r- g)
= P0/E0

Question 24

Price to Book - advantages

Answer 24

• BV almost always greater than 0
• BV more stable than EPS
• Measures NAV for FIs

Question 25

Price to Book - disadvantages

Answer 25

- Size differences cause misleading comparisons - Influences by accounting choices - BV cannot equal market value due to inflation/tech

Question 26

justified PB

Answer 26

= (ROE - g)/(r-g)

Question 27

DuPont

Answer 27

ROE = NI/S * Sales/TA * TA/E

Question 28

Price to cash flows - Advantages

Answer 28

- cash flow harder to manipulate than EPS - More stable than PE - Mitigates earnings quality concerns

Question 29

Price to cash flows - disadvantages

Answer 29

- difficult to estimate true CFO | FCFE better but more volatile

Question 30

RI Models

Answer 30

``` RI = Et - (r x Bt-1) = (ROE - r) * Bt-1 t-1 Et = expected EPS for year t Bt-1 = book value per share in the year t-1 ```

Question 31

Single Stage RI

Answer 31

Vo = Bo +[(ROE - r) * Bo/ (r-g)]

Question 32

Economic Value added

Answer 32

``` EVA = NOPAT - $WACC NOPAT = EBIT(1-t) ```

Question 33

Private Equity valuation - DLOC

Answer 33

DLOC = 1 - [1/(1 + control)]

Question 34

Residual Income

Answer 34

NI - stock holders opportunity cost. | Required return * total equity

Question 35

MVA market value added

Answer 35

MVA= market value - total capital

Question 36

How to calculate value of equity using ccm capitalized cash flow method

Answer 36

Value of equity = FCFE1/(r-g)

Question 37

Calculate Justified price to BV

Answer 37

(Roe - g)/ (r - g)

Question 38

Clean surplus

Answer 38

ending book value = beginning book value + net income - dividends may not hold when items bypass the income statement and affect equity directly. Foreign currency gains and losses under the current rate method bypass income statement and are reported under shareholders equity as CTA

Question 39

Relative-strength indicators

Answer 39

The belief that there are patterns of persistence or reversals in returns provides the rationale for valuation using relative strength indicators. There has been a considerable amount of empirical research in this area. Research suggests that the investment horizon is also an important determining factor in the appearance of these patterns.

Question 40

how to unlever and lever a beta

Answer 40

= beta x 1/ (1 + debt/equity) to lever = unlevered beta x (1 + debt/equity)

Question 41

PRAT

Answer 41

Profit margin Retention ratio Asset Turnover T - leverage

Question 42

The guideline transactions method he guideline public company method The prior transaction method

Answer 42

The guideline transactions method (GTM) generates a value estimate based on pricing multiples associated with the acquisition of control of entire companies. The guideline public company method (GPCM) generates an estimate of value based on the multiples from trading activity in the shares of public companies that are similar to the private company in question. The prior transaction method (PTM) uses actual transactions in the stock of the subject private company.

Question 43

an example of a transaction-related valuation for a private company

Answer 43

Venture capital financing, initial public offering (IPO), bankruptcy proceeding, performance-based managerial compensation, and sale in an acquisition are all examples of transaction-related valuations for a private company.

Question 44

Tax burden ratio

Answer 44

Tax burden = NI/EBT or 1 - the effective tax rate.

Question 45

Equity risk premium formula

Answer 45

Equity risk premium = forecasted dividend yield + consensus long term earnings growth rate - long-term government bond yield.

Question 46

Excess Earnings

Answer 46

The excess earnings method values tangible and intangible assets separately; this method is useful for small firms and when there are intangible assets to value. In the free cash flow method, a firm is valued by discounting a series of discrete cash flows plus a terminal value. In the capitalized cash flow method, a firm is valued by discounting a single cash flow by the capitalization rate.

Question 47

Asset-based approach

Answer 47

The asset-based approach is usually not used for most going concerns, but is appropriate for troubled firms, finance firms, investment companies, firms with few intangible assets, and natural resource firms. It values equity as the asset value of a firm minus the debt value of the firm.