Financial Valuation Methods: Part 1_M6

Question 1

What is the formula for free cash flows?

Answer 1

Net Income before taxes + non-cash expense (Depr.) - increase in working capital - capital expenditure.

Question 2

What does the discount model assume?

Used to value the shares of common stock.

Answer 2

• The stock price will grow at the same rate as the dividend, producing a constant growth rate.
• Compounding growth is exponential, not linear.
• The growth rate is less than the discount rate.

Question 3

What is trade credit?

Answer 3

• Is subject to risk of buyer default.
• Is usually an expensive source of external financing.
• Is not a source of long-term financing to the seller.
• Is an important source of financing for small firms.

Question 4

What is the Gordon zero growth model?

Answer 4

Price = Dividend/Discount Rate.

Question 5

What are the valuation estimation techniques?

Answer 5

Price-Sales-Ratio

• Uses sales per share as a basis for valuation
• Can be used in start-up situations or under conditions where earnings data is not meaningful.

PEG Projections

• Rely on meaningful earnings figures.

P/E Ratio

• Projections rely on meaningful earnings figures.

Constant growth models

• (D/(r-g)) are less adaptable to low earnings situations than the price-sales-ratio.
• Require adjustments to return and growth amounts to produce realistic results.