Financial Valuation methods Prt 1 Flashcards
An underlying assumption of the ____________________ is the idea that the stock price will grow at the same rate as the dividend.
constant growth dividend discount model
The constant growth model assumes that the growth rate is less than the _______________.
discount rate.
A stock priced at $50 per share is expected to pay $5 in dividends and trade for $60 per share in one year. What is the expected return on this stock?
A. 10%
B. 20%
C. 25%
D. 30%
Choice “D” is correct. The expected return is $15, which consists of the $5 in dividends
and the $10 increase in stock value from $50 to $60. A $15 return on a $50 investment yields a return of 30% ($15/$50).
Using a zero growth model, the price of a company’s stock is equal to ______________.
P = D/R
Price = Dividend / discount rate
Discount rate = desired rate of return
What is the formula and the steps to calculate price from a dividend, assuming that a company wants to account for price at a future time (ex. 2 years in the future)?
Terms are defined as:
P[t] = Current price (price at period “t”)
D[t+1] = Dividend one year after period “t”
R = Required return (aka discount rate)
G = Dividend Growth rate
Step 1, Compute dividend in subsequent year:
D[t+1] = Current dividend * (1 + G)^y
note: y = how many years in the future. Ex. for two years you would raise (1+G) to the 2nd power. For three years to the 3rd power.
Step 2, Apply growth rate to computed dividend:
P[t] = D[t+1] / (R-G)
*example: if D[t+1] = $22.05
P[t] = (22.05 x 1.05) / (.10-.05)
P[t] = 23.15/.05 = $463*
Higher P/E ratios generally indicate that
Investors are anticipating more growth and are bidding up the price of the shares in
advance of performance.
The P/E ratio measures the amount that investors are willing to pay for each dollar of earnings per share.
High P/E ratios generally indicate investor confidence in earnings growth, NOT that performance that has peaked or will soon fall.
What is the formula to calculate free cash flow?
Free Cash Flow = Net income + Noncash expenses − Increase in working capital − Capital expenditures.
An analyst notes the current price of Karnani Enterprises stock is $15 per share while the EPS is $3. If the PEG ratio is 1.25, what has the analyst projected as the growth rate for Karnani Enterprises?
A. 25%.
B. 20%.
C. 5%.
D. 4%.
Choice “D” is correct. The PEG ratio is the ratio of the P/E ratio to the anticipated
growth rate. In this case, we would express the PEG ratio as follows:
PEG = (P0 / E0 ) / (G × 100)
1.25 = ($15 / $3) / (G × 100)
1.25 = 5 / (G × 100)
G × 125 = 5
in other words 125G = 5
G = 5 / 125
G = 4%
Choice “A” is incorrect. The analyst’s growth rate is not the PEG -1.
Choice “B” is incorrect. The analyst’s growth rate is not the earnings / price ratio (3/15).
Choice “C” is incorrect. The analyst’s growth rate is not the P/E ratio divided by 100.
What is the formula to use the PEG ratio to calculate stock price?
(P0) = PEG x E1 x G
example:
if PEG = 4, EPS = 10, and growth is expected to be 2.5%
Projected stock price = 4 * (10 * (1+G)) x 2.5
= 4 * 10.25 * 2.5
= 102.50
A valuation estimation technique that can be adapted to start up companies and other situations where earnings are very low is:
PRICE SALES RATIO
The price sales ratio uses sales per share as a basis for valuation and can be used in start-up situations or under conditions where earnings data is not meaningful.
