Intrinsic Valuation

Question 1

What does intrinsic value mean in business?

Answer 1

An intrinsic value refers to a valuation method used in measuring the financial status or strength of a company. this method of business valuation uses Discounted cash Flows (DCF) in assessing the wealth of a company.

Question 2

Is the absolute value of a business same from its relative value?

Answer 2

No

Question 3

What is the difference between the absolute value and relative value of a company?

Answer 3

An absolute value examines a company’s wealth using the time value of money and accumulate interest, while relative value models gauge a company’s wealth by comparing it to its competitors’ wealth.

Question 4

Compare and Contrast enterprise value and equity value

Answer 4

Enterprise value and equity value are two common ways that a business may be valued in a merger or acquisition. Both may be used in the valuation or sale of a business, but each offers a slightly different view. Enterprise value gives an accurate calculation of the overall current value of a business, similar to a balance sheet, while equity value offers a snapshot of both current and potential future value.

Question 5

What is enterprise value?

Answer 5

It constitutes more than just outstanding equity. It theoretically reveals how much a business is worth, which is useful in comparing firms with different capital structures since the capital structure doesn’t affect the value of a firm.

Question 6

How to calculate enterprise value?

Answer 6

By adding up the market capitalization, or market cap, plus all of the debts in the company, substract any cash or cash equivalents that the company holds. You then get the enterprise value

Debts may include interest due to shareholders, preferred shares, and other such things that the company owes.

Question 7

What is equity value?

Answer 7

Equity value constitutes the value of the company’s shares and loans that the shareholders have made to the business

Question 8

How to compute equity value?

Answer 8

The calculation for equity value adds enterprise value to redundant assets ( non-operating assets)and then substracts the debt net of cash available.

Total equity value can then be further broken down into the value of shareholders’ loans and (both common and preferred) shares outstanding

Question 9

Are preferred shares and shareholders’ loans considered debt?

Answer 9

Yes. Equity value includes these instruments in its calculation

Question 10

What is the difference between the calculation of enterprise value and equity value?

Answer 10

Equity value uses the same calculation as enterprise value but adds in the value of stock options, convertible securities and other potential assets of liabilities for the company

Question 11

What sets equity value apart from enterprise value?

Answer 11

Because equity value consider factors that may not currently impact the company, but can at any time, equity value offers an indication of potential future value and growth potential.

Question 12

What is the intrinsic value of a business

Answer 12

It is the present value of all expected future cash flows, discounted at the appropriate discount rate.

Question 13

What makes intrinsic value different from relative forms of valuation?

Answer 13

Unlike relative forms of valuation that look at comparable companies, intrinsic valuation looks only at the inherent value of a business on its own.

Question 14

What are the two main methods of risk adjusting the intrinsic value?

Answer 14

Discount Rate and Certainty Factor

Question 15

What is the discount rate approach?

Answer 15

It uses a discount rate that includes a risk premium in it to adequately discount the cash flows.

In the discount rate approach, a financial analyst will typically use a company’s weighted average cost of capital.

Question 16

What is the formula of WACC?

Answer 16

the formula for WACC includes the risk-free rate plus a premium based on the volatility of the stock multiplied by an equity risk premium.

Question 17

What is the rationale behind the discount rate approach?

Answer 17

The rationale behind this approach is that if a stock is more volatile it’s a risker investment. therefore, a higher discount rate is used, which has the effect of reducing the value of cash flow that would be received further in the future (because of the greater uncertainty.)

Question 18

What is the certainty factor method?

Answer 18

it uses a factor on a scale of 0-100% certainty of the cash flows in the forecast materializing. In this approach, only the risk-fee rate is used as the discount rate, since the cash flows are already risk-adjusted.

Question 19

How can a certainty factor be assigned?

Answer 19

A certainty factor, or probability, can be assigned to each individual cash flow or multiplied against the entire net present value (NPV) of the business as a means of discounting the investment.

Question 20

How are the two approach similar?

Answer 20

They are both attempting to do the same thing—to discount an investment based on the level of risk inherent in it

Question 21

Why does intrinsic value matters to an investor?

Answer 21

Analysts employ these methods to see whether or not the intrinsic value of a security is higher or lower that its current market price, allowing them to categorize it as “overvalued” or “undervalued”

Question 22

It calculates the present worth of business by forecasting their future income streams

Answer 22

Intrinsic Valuation. a.k.a Absolute valuation

Question 23

Why is the absolute valuation method reductive?

Answer 23

The absolute valuation method is reductive as the analysis is focused on the characteristics of the company in isolation. There is no comparison to its competitors in the same indusctry or complementary sectors.

Question 24

Why is the process in absolute valuation problematic?

Answer 24

The process is problematic because the competitive analysis is important to assess the overall market movement in a particular sector. Disruptive innovation due to new technology, major mergers, and acquisitions, regulatory change, new market entrants, or bankruptcy may impact the trajectory of an entire sector.

Question 25

What are the two main types of intrinsic valuation models?

Answer 25

Discounted Cash Flow Model

Dividend Discounted Model

Question 26

TRUE OR FALSE: The discount rate equals the rate of return for the investor

Answer 26

True

Question 27

TRUE OR FALSE: Appropriate discount rates does not need to be calculated to arrive at the present value of the company

Answer 27

FALSE

Appropriate discount rates need to be calculated

Question 28

TRUE OR FALSE: The discounted cash flow model can be used for the valuation of anything that can affect cash flow

Answer 28

TRUE

Question 29

It uses a formula to calculate the rate of return of a business by evaluating anticipated payments and amounts receivable in the near future

Answer 29

DCF model

Question 30

TRUE OR FALSE:
The conclusion of using the DCF model is a projected cash flow that can be used to predict how long the company can sustain a growth trajectory.

Answer 30

TRUE

Question 31

What are the components of DCF model?

Answer 31

Free Cash Flow
Discount Rates
Period Number
Terminal Value

Question 32

It measure a company’s financial performance. It shows the cash that a company can produce after deducting the purchase of assets. In other words, it measure a company’s ability to produce what investors care most about: cash that’s available to be distributed in a discretionary way

Answer 32

Free Cash Flow (FCF)

• a component of DCF model

Question 33

What are the most common types of FCF

Answer 33

Unlevered Cash Flow

Levered Cash Flow

Question 34

Unlevered Cash Flow

Answer 34

This measure requires a multi-step calculation and is used in Discounted Cash Flow analysis to arrive at the Enterprise Value (or total firm value).

Question 35

Levered Cash flow

Answer 35

this measure is derived from the statement of cash flows by taking operating cash flow, deducting capital expenditures, and adding net debt issued (or substracting net debt repayment. This includes interest expense paid on debt and net debt issued or repaid, so it only represents the cash flow available to equity investors. ( interest to debt holders has already been paid)

Question 36

It is a hypothetical figure, an estimate of what it would be if the firm was to have no debt

Answer 36

Unlevered Cash Flow

Question 37

Why is free cash flow important?

Answer 37

knowing the company’s free cash flow enables management to decide on future ventures that would improve the shareholder value.

Question 38

What does an abundant Free cash flow indicates?

Answer 38

it indicates that a company is capable of paying its monthly dues. Companies can also use their FCF to expand business operations or pursue other short-term investments.

Question 39

What are Discount Rates? (Component of DCF)

Answer 39

the rate of return used to discount future cash flows back to their present value. It is often the company’s WACC, required rate of return, or the hurdle rate that investors expect to earn relative to the risk of the investment.