Midterm 4 Part 4 Flashcards
Where do you find changes in NWC?
Two balance sheets
Which rate do you use when solving with FCFF in the DCF equation?
WACC
What gets added in the FCFE equation?
Depreciation and Increases in net long term debt
What gets added in the FCFF equation?
Depreciation
What is another name for the Value of a firm?
Enterprise value
What is an IPO?
Initial public offering
Four reasons to know the value of a firm:
- Merger and Acquisition market
- Debt
- IPO
- Invest in Company (debt and equity values)
True or False: There are more MnA than IPOs
True
What is SOX
The Sarbanes-Oxley Act.
It created financial reporting rules to create consistency and prevent fraud.
What does LTV stand for?
Loan to value
True or False: Computing the market value of equity is hard
TRUE
True or False: Computing the market value of debt is hard
False, it’s easy because it almost always matches the books
What types of firms use the Replacement cost method?
Privately held firms, smaller companies, real estate (tangible assets)
Any company that would have an easier time (or no other choice) in valuing their assets at market value because they’re mostly tangible
How do you value tangible assets?
Appraisals
Market comparison
CMA (comparable marketing analysis)
Examples of intangible assets that are hard to value
Patents, copyrights, TMs/Trade secrets, Customer lists (which are SUPER important when starting a new company), and the brand name
Why is the value of the company equal to D + E?
Because valuing the other side of the equation (A=assets) is very difficult, but it’s easier to value debt and equity.
When market / book value is greater than 1, what type of equity is it?
Growth
When market / book value is less than 1, what type of equity is it?
Value
What is the difference between value and growth equity?
Value means the stocks have been undervalued, and growth means you believe they will get larger returns than average
What is an alternative method for deciding if equity is growth or value?
Using Beta.
If Beta is > 1, growth
If Beta is < 1, value
What does GFA stand for?
Gross fixed assets
How do you calculate the value of debt?
Use methods from chapter 6 or use book value as a proxy (because it’s very similar)
What three models can be used to find TV?
- GGM
- Perpetuity
- Comps
When calculating the value of a firm using the DCF method, is it 100% accurate?
No, because we’re using pro forma statements and estimating our best guess Terminal value
What is the market cap equation?
The number of shares x the price per share
True or False: Market value = market cap
True
What does market cap mean?
It is the total value of the publicly traded shares owned by the market.
What’s another word for comparable multiples?
Comps
What is the PE ratio?
It is the price to earnings ratio
P/E
True or False: The PE ratio has a unit of measurement
FALSE
It’s just a solitary number
When would you use the price to sales ratio?
When they don’t have price to earnings. This is typical for startup companies or IPOs
How many factors can you substitute in the PE ratio?
Anything you want. You could take any numbers and compare them to other companies (as long as they’re similar), and you usually would
What are the two main types of companies that use P/S instead of P/E?
Startups and IPOs
Other than P/E, what other ratios could you use for comps?
E/P = Earnings to yield
P/EBITDA = Price over EBITDA
M/B = market equity over book equity
When would you use P/EBITDA?
You would use this as a proxy for cash flows, new ventures and startups use it a lot
Explain briefly how to use the P/E and P/S ratios.
You would multiply your own sales by their price / sales, and your earnings by their price / earnings. The sales and earnings cancel out, and you’re left with the price.
The two numbers will not always be equal.
True or False: If a question gives you the RRR, you can use that rate for the WACC when solving for Value of the firm using DCF
TRUE
True or False: MACRS is always depreciated to 0
TRUE
True or False: MACRS uses a salvage value
FALSE
What are the capital budgeting steps?
- Evaluate cash flows, initial outlay, differential cash flows, and terminal value
- Assess risk
- Accept or reject
What are the three ways to value a firm?
Replacement cost, DCF, Comps
True or False: The DCF is such a broadly used equation because the CF can be switched out with ANY type of cash flow and ANY rate
TRUE
What are the 5 steps of DCF approach to valuing a firm?
- Construct pro forma statements
- Compute FCF for each year
- Estimate a terminal value and add it to the final forecasted year
- Compute an appropriate discount rate
- Use TVM to discount back to PV (each year, then add together)
True or False: You can use any ratio to compare firms (using comps method)
True
Price to sales, price to click, etc.
True or False: The Comps method is highly used in entrepreneurial finance
True
What are caveats?
Things that the methods don’t account for
What are the three caveats of valuing a firm?
- Taking out a salary
- Liquidity discount
- Control premium
What does the first caveat mean: Taking out a salary?
You can’t value a firm as if you don’t need to pay a CEO. You need to include the CEO’s salary as part of the valuation.
True or False: Private firms are less liquid
True
Why are private firms less liquid?
Because they have to jump through more hoops, there are more restrictions when selling assets
What is the discount rate between a private firm and a public firm?
A private firm will be 40-50% less valuable than a public firm
What is a control premium?
When somebody buys a controlling share of the firm. They have “controlling interest”. When that happens, a premium is added to the value
Is the control premium added to the value of a firm or subtracted from it?
Added
What is the control premium percentage range?
30-35%
Is the liquidity discount added or subtracted from the total value of the firm?
Subtracted, they are negative to the firm.
True or False: If a problem gives you FCFF but have not given you TV, you still have to calculate TV
True
True or False: When solving for the value of a firm, you need to know the number of stocks
FALSE
True or False: If you get the PE ratio as a decimal, you just multiply it by earnings or sales of the other company (you don’t turn it back into a fraction)
TRUE
What is the earnings yield?
When our PE ratio is inverted to become the earnings to price ratio.
True or False: Price to earnings is more accurate than price to sales
True
What was the dot com bubble?
Investment bubble fueled by internet-based companies in the 1990’s. Many of the companies that made an IPO ended up being worthless.
The P/S or P/C ratios were used during this era
What is the P/EBITDA ratio a proxy for?
It’s a proxy for cash flows using income statement data
Which model is used almost exclusively in entrepreneurial finance?
Comps
True or False: The salary caveat is mostly related to small businesses
True
Why is are public firms more liquid?
Because it’s VERY easy to buy/sell stocks in the stock market. Private firms have to find buyers themselves
What are some reasons why public firms are more liquid than private firms?
- Easier to trade stocks
- They disclose a lot more information
- Observable stock price
- They have passed the test of completing a successful IPO
Who pays the control premium?
The firm that is bidding for a controlling share of stock. They pay that firm extra money for that extra control (majority share). That money increases the firm’s value
How is an event study organized?
You put all the companies on the timeline with the event happening at time zero, regardless of when the company was founded
What is an event study?
You are plotting the changes in different firms after making some announcement or an event.
What is another name for control premium?
The jump
How much is “the jump”?
30-35%
What factors create value / create the jump?
- Supply chain
- Unused Debt
- Tax credits
- Downsize employees
- Combine facilities
What do the factors of the jump mean?
They happen when companies merge together. You don’t need as much debt, or employees, or facilities if you’re sharing now.
True or False: If you’re not buying a house in cash, you need to get a valuation appraisal
True
Who requires the appraisal?
Your mortgage company. They want to make sure you’re paying the amount that the house is actually worth, or else they’ll lose money
How are appraisals done?
By cost (replacement cost), by DCF, or comps
What are the two MAIN ways appraisals are done?
Cost or comps
True or False: Whenever possible, request a VA certified appraisal
True
Who should you get an appraisal from if you aren’t a veteran?
FHA
Why are VA and FHA services better than regular appraisals?
Because they aren’t as motivated to turn a profit and steal your money. They don’t play the game
Why must the appraiser make adjustments when using the comps method of valuing houses?
Because you probably won’t find two houses that are exactly the same. If your house has a porch and the other doesn’t, the appraiser will add value to your house.
They make adjustments to take value or add value whenever necessary to make the houses as equal in factors as possible.
True or False: When using comps to value houses, the average value of all the properties is the value listed
True
What are the two ways you have to fix a discrepancy between the appraisal and the offer?
- Owner could accept the appraisal
- Buyer would need to pay the difference out of pocket
Why is it important for the appraisal to match your offer as closely as possible?
Because the appraisal is the amount that the bank would be willing to loan you. If your offer is higher than the appraisal, you’ll have to pay the difference in cash.
What does FHA stand for?
Federal Home Association
True or False: Your house should be a consumption purchase not an investment
True
Just enjoy the house, you don’t need ot make money from it
Who has an incentive to get you to pay the highest price for a property?
Person selling it, selling agent, buying agent, Title company, appraiser, and the lender/bank
Who has an incentive to get you to pay the lowest price for a property?
Only you. You have to be educated and fight for yourself if you want a fair deal.
What is a buying agent?
The person representing the buyer
Why do so many people have incentives for you to pay more?
Because they earn commissions or a percentage of the selling price.
What is the back end / front end ratio?
Front end ratio determines how much of a person’s income can be allocated to a mortgage payment.
The Back end ratio determines how much of a person’s income is being allocated to other monthly payments (bills and such)
Why is the back end / front end ratio not accurate for LDS people?
Because LDS people pay 10% in tithing that it doesn’t account for, and they typically have more kids than the average the ratios are account for.
What is an MLS in real estate?
Multiple listing service
Examples of MLS’s
Zillow, realtor.com, etc.
How much do MLS services / realtor services typically make from the sale of a house?
4.5-6%
True or False: Some real estate agents can create value
True
What cut does a buyer broker make?
3%
What cut does as seller broker make?
1.5-3%
What is a homie?
A deep discount broker
What is a deep discount broker?
They are a broker that make smaller cuts than traditional discount brokers
What are discount brokers?
They mediate exchanges between buyers and sellers
