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Level 2 > Equity - Free Cash Flow Valuation > Flashcards

Equity - Free Cash Flow Valuation Flashcards

1
Q

Holding Period Return (HPR)

A

[(P1+CF1) / P0] - 1

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2
Q

Required Return = risk-free return + Beta*Equity Risk Premium

A

…

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3
Q

Gordon Growth Model Equity Risk Premium

A

= (1-year forecasted dividend yield on market index) + (consensus LT earning growth rate) - (LT government bond yield)
= D1/P + g - RLT

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4
Q

Supply Side Equity Risk Premium (Macroeconomic Model). Example Ibbotson-Chen

A

Equity risk premium = [1+i][1+rEg][1+PEg] - 1 + Y - Rf
= [1+expected inflation][1+expected real growth in EPS][1+expected change in P/E ratio] - 1 + Expected yield - Expected risk-free return

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5
Q

Risk Premium = Factor Sensitivity * Factor risk premium

A
  • Typically calculated for the macroeconomic models
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6
Q

Fama-French Macroeconomic model

A

= Rf + Betamkt(Rmkt-Rf) + Betasmb(Rsmall-Rbig) + Betahml*(Rhbm-Rlbm)
= Risk free rate + (Return on a value weighted market index-risk free rate) + (A small cap return premium equal to the average return on small cap portfolios - average return on large-cap portfolio) + (A value return premium equal to the average return on a high book-to-market portfolio - the average return on low book-to-market portfolios)

*baseline betas are all 0, except Betamkt = 1

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7
Q

Pastor-Stambaugh model vs Fama-French Model

A

Pastor Stambaugh model adds a liquidity factor to the Fama-French Model

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8
Q

Blume method

A

Adjusted Beta = 2/3*regressionBeta + 1/3

Betax,unlevered = Betax * [1/(1+Debt/Equity)]
BetaA = Betax,unlevered * [1 + (DebtA/EquityA)]
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9
Q

Weight Average Cost of Capital

A

WACC = Md(1-t)rd + Me*re

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10
Q

Forecast COGS

A

=(Historical COGS / Revenue) * Estimate of future revenue

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11
Q

Projected Inventory

A

Forecasted COGS / Inventory turnover

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12
Q

Project A/R

A

=DSO * (forecasted sales/365)

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13
Q

Return on invested capital

A

ROIC = Net operating profit after tax / (operating assets - operating liabilities)

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14
Q

One Period Dividend Discount Model

A

V0 = (D1+P1) / (1+r)

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15
Q

Multi-period Dividend Discount Model

A

V0 = D1/(1+r) + D2/(1+r)^2 +…+Dn/(1+r)^n

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16
Q

Gordon Growth Model

A

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

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17
Q

Present Value of Growth Opportunities

A

V0 = PVGO + (E1/r)

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18
Q

Justified Leading P/E

A

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

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19
Q

Justified Trailing P/E

A

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

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20
Q

Value of perpetual shares

A

= Dp / rp

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21
Q

Two Stage DDM

A

{[D0 + (1+gs)^t]/(1+r)^t} + {[D0 (1+gs)^n(1+gl)]/[(1+r)^n*(r-gl)]}

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22
Q

H-Model

A

V0 = [D0(1-gl)]/(r-gl) + [D0H*(gs-gl)] / (r-gl)

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23
Q

Sustainable Growth Rate

A

= retention ratio (b) * ROE = g

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24
Q

ROE

A

= (net income/sales) * (sales/Total Assets) * (Total Assets / Shareholders Equity)

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25
Q

PRAT Model

A

SGR = P(profit margin) * R(retention ratio) * A(asset turnover) * T (financial leverage)

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26
Q

Bond Yield Model

A

Required return = YtM on LT bonds + risk premium

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27
Q

Country Spread Model

A

Accounts for FX rate risk by using the difference in bond yields

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28
Q

Country risk rating model

A

Begins with model of a developed country , the modifies the model with risk premiums from a developing country to derive a total emerging market risk premium

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29
Q

Unlevering Beta takes out the company-specific risk and isolates the market risk

A

…Relever nonpublic or thinly traded public entities

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30
Q

Liquidation Value

A

= current market value of assets - current market value of liabilities

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31
Q

Including the historical returns biases the equity risk premium upwards due to the survivorship bias

A

…

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32
Q

Build up Method calculation for risk premium

A

required return = Rf + equity risk premium + size premium + specific company premium

Use build up method for closely held companies

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33
Q

Beta is the level of systematic risk

A

…

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34
Q

Conditions if there exists economies of scale

A

1) Big Firm OM > Small Firm OM
2) COGS%/Revenue of Big Firm > COGS%/Revenue of smaller firm
3) SGA%/Revenue of Small Firm < SGA%/Revenue of Big Firm

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35
Q

Cash Tax Rate

A

Total Tax / Revenue

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36
Q

Total dividend (using Retained Earnings)

A

= REbeg + Net Income - REend

37
Q

If the growth rate of a company’s dividend is too high, readjust the growth rate of the dividend to the growth rate of GDP.

38
Q

Use the residual income method, if the firm …

A

If the firm does not pay dividends, or has negative cash flows over the forecasted period.

39
Q

1-b vs. b

A 
(1-b) = dividend payout ratio
b = retention rate
40
Q

Current dividend

A

= EPS * payout ratio

41
Q

Sustainable growth rate

A

= ROE * retention rate

42
Q

Dividend discount models

A

define cash flow as the dividends to be received by shareholders

43
Q

Free Cash Flow to the Firm

A

defined as the cash flow generated by the firms current operations that is in excess of the capital investment required to sustain the firm’s current productive capacity.

44
Q

Free Cash Flow to Equity

A

Cash available to stockholders after funding capital requirement and expenses associated with debt financing.

45
Q

Residual Income models

A

Define the amount of earnings during the period that exceeds the investor’s required return.

46
Q

Retention ratio (b)

A

= (earnings - dividends) / earnings

47
Q

Dupont Formula

A

ROE = (net income / shareholders’ equity)(net income / sales)(sales/total assets)*(total assets/shareholders’ equity)

Then, since SGR = g = ROE * (1-b)
g = [(net income - dividends)/net income] * (net income/sales)*(sales/Total assets) *(total assets/ shareholders’ equity)

48
Q

PRAT Model

A

Sustainable growth rate (SGR) = g = Profit Margin (P) * Retention Ratio (R) * Asset Turnover (A) * Financial Leverage (T)

49
Q

FCFE = Net Income - (FCinv-Depreciation) - WCinv + net borrowing

50
Q

FCFE = Net Income - (1-DR)(FCinv - Dep) - (1-DR)WCinv

where,
DR = target debt to asset ratio

51
Q

FCFF = EBIT(1-t) + Depreciation -FCinv - WCinv

52
Q

Enterprise Value

A

= Firm value - cash & ST investments

53
Q

Use FCFE in most cases, except:

A

1) capital structure is volatile
2) company has FCFE < 0
3) Significant debt is outstanding

54
Q

FCFF = net income + NCC + [Interest Expense*(1-t)] - FCinv - WCinv

55
Q

FCFF = CFO + [Interest Expense*(1-t)] - FCinv

b/c CFO = Net income + NCC - WCinv

56
Q

FCFE = FCFF - [Interest Expense*(1-t)] + net borrowing

57
Q

FCFE = CFO - FCinv + Net borrowing

58
Q

FCFF = [EBITDA(1-t)] + (Depreciationt) - FCinv - WCinv

59
Q

Incremental FCinv

A

(Capital Expenditures - Depreciation) / (Change in Sales)

60
Q

Incremental WCinv

A

Change in WC / Change in Sales

61
Q

Two stage FCFF

A

[FCFFt/(1+WACC)^t] + {[FCFFn+1 / (WACC-g)] * [1/(1 + WACC)^n]}

62
Q

Trailing P/E

A

market price per share / EPS over previous 12 months

63
Q

Leading P/E

A

Market price per share / Forecasted EPS for next 12 months

64
Q

Book value of equity

A

= (Total assets - Total liabilities) - preferred equity

65
Q

Normalize EPS by

A

ROE * BVPS

66
Q

Justified trailing P/E

A

[(1-b)*(1+g)] / (r-g)

67
Q

Justified leading P/E

A

(1-b) / (r-g)

68
Q

Yardeni Model

A

CEY = CBY - K*LTG + Error

Current Earnings Yield = Current Moody’s A rated bond yield - constant*5year consensus earnings g.r.

69
Q

P/E - to - earnings growth (PEG)

70
Q

Enterprise Value

A

= Market value of common stock + Market value of preferred equity + Market value of debt + minority interest - cash and investments

71
Q

Earnings surprise

A

= reported EPS - expected EPS

72
Q

Standardized unexpected earnings

A

SUE = Earnings surprise / standard deviations of earnings surprise

73
Q

Justified P/B Ratio

A

(ROE - g) / (r-g)

74
Q

Justified P/S Ratio

A

[(E/S) * (1-b) * (1+g)] / (r-g)

75
Q

Justified P/CF Ratio

A

[FCFE * (1+g)] / (r-g)

76
Q

Justified Dividend Yield

A

(r-g) / ( 1+g)

77
Q

Trailing P/E

A

(P/S) / net profit margin

78
Q

Leading P/E

A

Trailing P/E / (1+g)

79
Q

Expected growth in dividend and earnings

A

= ROE * (1-payout ratio)

80
Q

g = retention rate * E/S * Sales/Assets * Assets/Shareholders’ Equity

81
Q

g = retention rate * E/S * Sales/Assets * Assets/Shareholders’ Equity

82
Q

Residual Income

A

= Earnings - (r * Bt-1)

= (ROE-r) Bt-1

83
Q

Single Stage Residual Income Valuation

A

V0 = B0 + [(ROE-r)/(r-g) * B0]

84
Q

Residual Income

A

= Net Income - Equity Charge
= Net Income - (Equity Capital * Cost of Equity Capital)
OR
= Net Operating Profit - Capital Charge
= Net Operating Profit - Equity Charge - Debt Charge
=NOPAT - (Equity Capital * Cost of Equity) - (Debt CapitalCost of Debt(1-t))

85
Q

Retention Ratio (b)

A

= (EPS - Dividend) / EPS

86
Q

ROE = EPS / BVPS

87
Q

Residual Income is the book value of the firm plus the present value of the firms’ economic profits.

A

RI is used to measure goodwill impairment, management effectiveness and equity value.

88
Q

Firms making more aggressive accounting decisions will report higher book values and lower future earnings

89
Q

Value of intangibles

A

= [RI * (1+g)]/(discount rate of intangibles - growth of residual income)

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