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ICAS - AFin > Module 5 > Flashcards

Module 5 Flashcards

1
Q

Reasons for valuations (3)

A
  • Fiscal transactions eg tax liability
  • Legal valuations
  • Commercial transactions
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2
Q

Discount applied to valuation for restrictions on transferability

A

20%

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3
Q

< 10% shareholding

A
  • No other influence on company’s affairs

- Rarely any benefit other than dividends and possible capital growth

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4
Q

10 - 25% shareholding

A
  • If > 15%, right to appeal to the court on a variation of rights
  • > 20% allows the inclusion of an associated company’s results
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5
Q

25 - 49.9% holding

A
  • Right to prevent special resolution being passed

- Closer proximity to 50% increases prospects of acquiring further shares to create a controlling interest

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6
Q

50%

A
  • Associate
  • Percentage >50% is required for control
  • Gives the power to block any resolution put to a general meeting
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7
Q

75%

A

In addition to control, ability to pass any resolution (including special resolution such as winding up)

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8
Q

90% or more

A

Full control with no hindrance

Can make mandatory offer for shares of remaining minority (squeeze out)

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9
Q

Four main methods of valuation

A
  • Dividend method
  • Earnings method
  • Discounted cash flow method (DCF)
  • Asset valuation
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10
Q

Dividend method (2 ways)

A
  • Dividend valuation model

- Dividend yield model

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11
Q

Dividend valuation model step 1

A

Calculate the present value of the stream of future dividend payments

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12
Q

Dividend yield method - value of share =

A

Dividend per share / required dividend yield %

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13
Q

Problems with dividend valuation model

A

Hard to determine factors such as expected growth rate/ required rate of return

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14
Q

Comparable quoted company

A

Quoted company with similar characteristics to the unquoted company such as similar industry and risk profile

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15
Q

Adjustments to yield made to reflect differences between CQC and unlisted company (4)

A
  • Marketability (unlisted companies find it harder to find buyers for shares)
  • Transferability (share transfer restrictions may exist)
  • Size (smaller companies less able to withstand market shocks)
  • Other factors (positive factors eg strong competitive advantage, exceptional prospects for profit growth, short term expectation for future flotation)
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16
Q

Adjustment for negative factor > dividend yield method

A

Added to dividend yield

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17
Q

Adjustment for positive factor > dividend yield method

A

Deducted from dividend yield

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18
Q

Lack of marketability %

A

20%

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19
Q

Potential flotation %

A

10%

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20
Q

The earnings method determines

A

The maximum annual cash dividend that the ordinary shareholders could pay themselves out of current year profits

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21
Q

Earnings basis removes

A

The uncertainty of a company’s dividend policy from the valuation exercise

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22
Q

Problem with the PE method

A

Relies heavily on having a PE ratio for an unquoted company’s shares (which is not readily available)

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23
Q

Adjustment for negative factor > PE method

A

Decrease PE ratio

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24
Q

Adjustment for positive factor > PE method

A

Increase PE ratio

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25
Q

Three main options for determining future maintainable earnings (FME)

A
  • One year’s historic earnings
  • Average historic earnings
  • Forecast earnings
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26
Q

Remove one off items from

A

One year’s historic earnings AND average historic earnings

27
Q

Advantage of historic earnings method

A

Spreads volatility

28
Q

Disadvantage of forecast earnings method

A

PE ratios already include perception of the future, so growth is double counted

29
Q

Profit figure for FME always

A

Post tax profits

30
Q

Earnings valuation basis used to

A

Value controlling interests in unlisted companies

31
Q

Discounted cash flow method derives

A

The value of a company’s shares

32
Q

Differences between NPV and DCF > Cash flows

A 
NPV = before finance costs
DCF = after finance costs (but before ordinary dividends)
33
Q

Differences between NPV and DCF > Discount rate

A 
NPV = WACC
DCF = purchasers cost of equity (derived using CAPM)
34
Q

DCF cashflows should be discounted at

A

Purchasers cost of equity

35
Q

Situation where DCF valuation method will be required (3)

A
  • Venture capitalist requires valuation of the shares before providing finance
  • Trade sale of the whole company to a competitor
  • Director is retiring and wants to sell their shares to another director
36
Q

DCF method cash flows

A

Include all cashflows except those relating to equity (share issues, share repurchases and dividends).
Preference dividends -> if accounted for as debt = include, if equity = exclude

37
Q

Shareholder value analysis (SVA)

A

Value of a business is determined by seven factors (value drivers)

38
Q

SVA Driver 1

A

Corporate tax rate

39
Q

SVA Driver 2

A

Cost of capital

40
Q

SVA Driver 3

A

Investment in non-current assets

41
Q

SVA Driver 4

A

Investment in working capital

42
Q

SVA Driver 5

A

Life of projected cash flows

43
Q

SVA Driver 6

A

Operating profit margins

44
Q

SVA Driver 7

A

Revenue growth rate

45
Q

Asset valuation only calculated in isolation if

A

Unlisted company were being bought with the intention of winding the company up

46
Q

Valuation basis > minority interest

A

Dividend basis

47
Q

Valuation basis > significant minority

A

Earnings basis with extra discount for lack of control

48
Q

Valuation basis > majority interest

A

DCF, earnings and going concern assets bases

49
Q

Issues with valuing start ups (4)

A
  • No track record
  • Ongoing losses
  • Unknown competition
  • Inexperienced management
50
Q

Start up > asset valuation method

A

Inappropriate > most of investment in start up are intangible assets eg people/ IP

51
Q

Start up > earnings valuation method

A

Difficult to find CQC with similar risk profile + no earnings

52
Q

Start up > dividend valuation method

A

Start up unlikely to pay dividend (will reinvest instead)

53
Q

Start up > DCF valuation method

A

Likely to be most valid - assuming cash flows can be forecast and appropriate discount rate can be found

54
Q

Loss making enterprises - valuation

A

Consider management/ product being sold

55
Q

Contingent assets/ liabilities - valuation

A

Not included in valuation as not in financial statements - may need to consult expert to see if they will impact value and should be included

56
Q

Value in use =

A

Value of an asset in the opinion of the owner

57
Q

Negotiation considerations (2)

A
  • Value in use

- Replacement cost (cost of setting up business from scratch)

58
Q

Finance theory assumes

A

Investors behave rationally

59
Q

Factors that impact overvaluation problem (3)

A
  • Overconfidence
  • Herd behaviour
  • Availability bias
60
Q

Availability bias

A

Decision making may be affected by available information even if not relevant (eg anchoring)

61
Q

Irredeemable instruments

A

Treat as a perpetuity

62
Q

Redeemable instruments

A

Valuation discounts the cash flows arising from the instrument (don’t forget capital repayment on redemption)

63
Q

Intangible assets

A

Can be extremely valuable in a business and should not be ignored

ICAS - AFin (21 decks)

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