Equity Flashcards
What is the formula for the difference between the analyst’s estimate of intrinsic value and the current market price?
IVanalyst - Price = (IVanalyst - IVactual) + (IVactual - Price)
When is investment value used?
When the company in question is being acquired.
Are conglomerates more likely to be value at a premium or a discount?
A discount.
What is the formula for calculating Equity Risk Premium using the GGM model?
ERP = (d/P) + g - r
What will be the effect of using arithmetic average vs geometric average for historical equity returns when estimating equity risk premium?
Arithmetic average will be higher, so equity risk premium will be higher.
What will be the effect of using short-term treasury bill rate vs longer-term bond rates when estimating equity risk premium?
Short-term treasury bill rate will be lower, so equity risk premium will be higher.
For a public company, how can a beta be estimated?
A beta can be estimated by regressing historical returns and then adjusting for beta drift.
What is the formula for adjusted beta?
Adjusted Beta = (Beta x 2/3) + 1/3
What does the country spread model do?
It takes a developed market return and adds an emerging market premium.
What does the country risk rating model do?
It estimates an equation for developed equity risk premium and then uses this and EM inputs to estimate an EM equity risk premium.
What is the formula for sustainable growth rate (SGR)?
SGR = ROE x Retention Ratio
What are the formulas for valuing the long-term growth and short-term growth stages of a H-Model?
Long-Term V = d1/r-gL
Short-term V = (d0 x n/2 x (gS-gL)) / r - gL
What is the formula for justified leading P/E?
Payout Ratio / r - g
What is the formula for justified trailing P/E?
Payout Ratio x (1+g) / r - g
What is the formula for residual income?
RI = (ROE - r) x B0
or
RI = NI - (B0 x r)
What is the formula for the single-stage residual income model?
V0 = B0 + ((ROE - r) x B0) / r -g
If there is expected to be no residual income after time T, how do you calculate terminal value?
Terminal Value = RI at time T / 1 +r
What is the formula for the value of a stock a declining RI?
V0 = RI at time T / t + r - w
What will be the effect on ROE and Book Value of incorrectly capitalising expenditures?
They will be overstated.
What is the formula for valuing a firm under the Excess Earnings Method (EEM)?
EEM = Fixed Assets + Working Capital + Residual Income
What is an alternative method of estimating required return when no comparable public companies are available?
When there are no comparable public companies there will be no comparable betas to use, so the build-up method is used.
Under what circumstances can CAPM be used to estimate required return of a private firm?
If the firm is of similar size and specific risk to a public company.
When is a control premium added?
When the investor is a strategic buyer.
What is the formula to calculate DLOC from control premium?
DLOC = 1 - (1 / Control Premium)
What multiple should you use for a highly cyclical firm?
Normalised Price-Earnings
What is the formula for valuation that includes PVGO?
V = (E1/ r) + PVGO
What is the formula for justified Price/ Book?
Justified P/B = (ROE-g) / r-g
What is the formula for justified Price/Sales?
Justified P/S = EBIT Margin (1+g) / r-g
What is the formula for Market Value Added (MVA)?
MVA = Market Value - Book Value
Which discount rate is residual income discounted at?
Cost of equity.
What is the formula for real growth rate?
Real Growth Rate = 1 + g / 1 + i
When capital structure is simple and stable, what is the preferred valuation method - FCFF or FCFE?
FCFE, as it is easier to calculate.
How do repurchases and share issues affect FCFF and FCFE?
They do not. Only new debt issue affects FCFE.
What is the formula for cash flow from operations?
CFO = NI + Depr - NWCInv
What is included in the Pastor Stormbaugh model that is not included in the Fama-French model?
A liquidity premium.
What is the formula for expected dividend based on the target payout model?
Expected Dividend = Increase in Earnings * Target Payout Ratio * 1/n
Does dividend policy affect required return on equity?
Yes - an unstable dividend policy will increase required return on equity.
What is a better representation of capital available to all stakeholders - EBITDA or NI?
EBITDA, as it is pre-interest.
Would a risk premium based on a public company be too high or too low for a private company?
Too high.
What does sustainable growth rate assume with regards to capital structure?
When earnings are retained, more debt is issued in order to keep capital structure constant.
When establishing the capital structure of a company, do you use market values or book values of debt and equity?
Market values.
Note: If debt is trading at par, then MV = BV.
What does the residual income model assume will happen to return on equity in the long run?
Competition will drive it down to the cost of capital, as competition will mean that supernormal earnings cannot be earned in the long run.
