Lecture 2

Question 1

What are the implementation problems with comparable analysis

When is comparable most useful

Answer 1

Implementation Problems

• finding comparable that match precisely
• different accounting method
• different prices from different multiple
• negative denominators
• different capital structures can affect multiples

Application
- Useful to price IPO’s and thinly traded firms

Question 2

define technical screens.

What are the different type of screens (6 points)

Answer 2

Technical screens: identify position based on trading indicators

Price screens 
Small stock screens 
Neglected stock screens 
Seasonal screens 
Momentum screen 
insider trading screens

Question 3

define fundamental screens

What are some fundamental screens

How do you profit from fundamental screens

Answer 3

Fundamental screens: identify positions based on fundamental indicators of the firms operations relative to price

Price / earnings
Price / Book value
Price / Cash Flow
Price / Dividends

The idea here is buy firms with low multiples and short sell those with high multiples

Question 4

What are stock with high multiples are called

Stocks with low multiples are called

Answer 4

Growth or Glamour or fashionable stocks (usually overpriced)

Value stocks or Contrarian stocks (likely to be under priced)

Question 5

According to the Dividend discount model what is the value of the equity

What are the situation for terminal values

Answer 5

The present value of the future dividends discounted by the price of equity

Growth or no growth. Remember you discount the next period dividend to get the value at the terminal point.

Question 6

What are the advantage and disadvantage of the DDM (2 points in each)

when is the best to use the dividend discount model

Answer 6

Advantage

• easy concept
• predictability are fairly stable in the short run

Disadvantage

• Relevance: not related to value but a payout out of earnings
• forecast horizons: If a firm is not expected to payout dividends for a longer periods then its difficult to calculate the terminal value

Works best: When payout is permanently tied to the value generation in the firm. Fixed payout ratio.

Question 7

What is the formula for free cash flows

What discount rate do you use

What are the two cases for continuing value

What is the formula for “value of net debt” and how does it apply to FCF

Answer 7

FCF = Cash used in operations - Cash used in investments

Weighted average cost of capital

No growth perpetuity or growing perpetuity. Remember to get the CV at the terminal point you use the FCF one period in front of the TV and if you use the perpetuity formula you get the CV at the terminal point.

Value of net debt = Debt obligation - debt assets + preferred equity. You must subtract the value of net debt from the value of assets (from FCF model) to calculate the value of equity.

Question 8

What are the basic steps to calculate the SP from FCF model

Answer 8

Discount FCF
Discount CV
= Value of assets

Value of assets - Net Debt = Value of equity

Value of equity / No shares outstanding = SP*

If market SP > SP* then overvalued