Goldfarb

Question 1

How high growth rates affect dividends

Answer 1

High growth rates not sustainable; offset by lower dividend amounts

Question 2

How high growth rates affect risk-adjusted rate

Answer 2

High growth rates tend to be riskier

Question 3

Difference between private valuation and equilibrium market valuation

Answer 3

Private valuation assumes individuals have own views of risk. Equilibrium market assumes all individuals have same view of risk

Question 4

Two ways of determining beta in CAPM

Answer 4

Use a firm beta (linear regression of company’s returns)

Use industry beta (mean or median value)

Question 5

If industry beta is being used, describe two adjustments that may need to be made

Answer 5

Mix of business match
Financial leverage (beta can be defined to reflect solely business risk)

Question 6

Two limitations of DDM

Answer 6

Actual dividends are discretionary/difficult to forecast

Dividend definition could include stock buybacks

Question 7

Two approaches for implementing discount cash flow model

Answer 7

FCFF
FCFE (preferred, to avoid WACC for policyholder liabilities)

Question 8

Why DDM and discounted cash flow model should use different discount rates

Answer 8

DDM’s discount rate > FCFE, since in FCFE all free cash flow is paid out to shareholders

Question 9

Three weaknesses of discounted cash flow method

Answer 9

1. Must forecast
2. Variety of adjustments need to be made
3. Resulting FCFs may vary to those in planning

Question 10

Abnormal earnings

Answer 10

Assumes abnormal earnings will not continue into perpetuity but will decline to zero

Question 11

Why AE is appealing for terminal value

Answer 11

Forces analysts to explicitly consider limits of growth from a value perspective

Question 12

Two adjustments to book value needed to implement AE method

Answer 12

Eliminate systematic bias in reported assets/liabilities

Adjust reported BV to reflect tangible BV

Question 13

Two benefits of AE

Answer 13

Uses assumptions directly tied to value creation

Deemphasizes terminal value, and reflects within forecast horizon

Question 14

Two reasons why relative valuation using multiples might be preferred over DDM

Answer 14

Investor may not have access to data in enough detail

Horizon used may stretch limits of forecasting ability

Question 15

Three alternative uses to P-E ratios

Answer 15

Validation of assumptions
Shortcut to valuation
Terminal value

Question 16

Difference between market multiples and transaction multiples

Answer 16

Market multiples are based on market price of companies’ shares; transaction mulitples are based on M&A prices or IPOs

Question 17

One advantage of using transaction multiples to value firms

Answer 17

Price is based on complex negotiation with sophistication, so are more meaningful

Question 18

Three disadvantages of using transaction multiples to value firms

Answer 18

Control premiums (buyer pays more than worth)
Overpricing (overpaying)
Reported financial variables (buyer may have different underlying assumptions)