Module 5

Question 1

Reasons for valuations (3)

Answer 1

• Fiscal transactions eg tax liability
• Legal valuations
• Commercial transactions

Question 2

Discount applied to valuation for restrictions on transferability

Answer 2

20%

Question 3

< 10% shareholding

Answer 3

• No other influence on company’s affairs

- Rarely any benefit other than dividends and possible capital growth

Question 4

10 - 25% shareholding

Answer 4

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

Question 5

25 - 49.9% holding

Answer 5

• Right to prevent special resolution being passed

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

Question 6

50%

Answer 6

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

Question 7

75%

Answer 7

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

Question 8

90% or more

Answer 8

Full control with no hindrance

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

Question 9

Four main methods of valuation

Answer 9

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

Question 10

Dividend method (2 ways)

Answer 10

• Dividend valuation model

- Dividend yield model

Question 11

Dividend valuation model step 1

Answer 11

Calculate the present value of the stream of future dividend payments

Question 12

Dividend yield method - value of share =

Answer 12

Dividend per share / required dividend yield %

Question 13

Problems with dividend valuation model

Answer 13

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

Question 14

Comparable quoted company

Answer 14

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

Question 15

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

Answer 15

• 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)

Question 16

Adjustment for negative factor > dividend yield method

Answer 16

Added to dividend yield

Question 17

Adjustment for positive factor > dividend yield method

Answer 17

Deducted from dividend yield

Question 18

Lack of marketability %

Answer 18

20%

Question 19

Potential flotation %

Answer 19

10%

Question 20

The earnings method determines

Answer 20

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

Question 21

Earnings basis removes

Answer 21

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

Question 22

Problem with the PE method

Answer 22

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

Question 23

Adjustment for negative factor > PE method

Answer 23

Decrease PE ratio

Question 24

Adjustment for positive factor > PE method

Answer 24

Increase PE ratio

Question 25

Three main options for determining future maintainable earnings (FME)

Answer 25

- One year's historic earnings - Average historic earnings - Forecast earnings

Question 26

Remove one off items from

Answer 26

One year's historic earnings AND average historic earnings

Question 27

Advantage of historic earnings method

Answer 27

Spreads volatility

Question 28

Disadvantage of forecast earnings method

Answer 28

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

Question 29

Profit figure for FME always

Answer 29

Post tax profits

Question 30

Earnings valuation basis used to

Answer 30

Value controlling interests in unlisted companies

Question 31

Discounted cash flow method derives

Answer 31

The value of a company's shares

Question 32

Differences between NPV and DCF > Cash flows

Answer 32

``` NPV = before finance costs DCF = after finance costs (but before ordinary dividends) ```

Question 33

Differences between NPV and DCF > Discount rate

Answer 33

``` NPV = WACC DCF = purchasers cost of equity (derived using CAPM) ```

Question 34

DCF cashflows should be discounted at

Answer 34

Purchasers cost of equity

Question 35

Situation where DCF valuation method will be required (3)

Answer 35

- 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

Question 36

DCF method cash flows

Answer 36

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

Question 37

Shareholder value analysis (SVA)

Answer 37

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

Question 38

SVA Driver 1

Answer 38

Corporate tax rate

Question 39

SVA Driver 2

Answer 39

Cost of capital

Question 40

SVA Driver 3

Answer 40

Investment in non-current assets

Question 41

SVA Driver 4

Answer 41

Investment in working capital

Question 42

SVA Driver 5

Answer 42

Life of projected cash flows

Question 43

SVA Driver 6

Answer 43

Operating profit margins

Question 44

SVA Driver 7

Answer 44

Revenue growth rate

Question 45

Asset valuation only calculated in isolation if

Answer 45

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

Question 46

Valuation basis > minority interest

Answer 46

Dividend basis

Question 47

Valuation basis > significant minority

Answer 47

Earnings basis with extra discount for lack of control

Question 48

Valuation basis > majority interest

Answer 48

DCF, earnings and going concern assets bases

Question 49

Issues with valuing start ups (4)

Answer 49

- No track record - Ongoing losses - Unknown competition - Inexperienced management

Question 50

Start up > asset valuation method

Answer 50

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

Question 51

Start up > earnings valuation method

Answer 51

Difficult to find CQC with similar risk profile + no earnings

Question 52

Start up > dividend valuation method

Answer 52

Start up unlikely to pay dividend (will reinvest instead)

Question 53

Start up > DCF valuation method

Answer 53

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

Question 54

Loss making enterprises - valuation

Answer 54

Consider management/ product being sold

Question 55

Contingent assets/ liabilities - valuation

Answer 55

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

Question 56

Value in use =

Answer 56

Value of an asset in the opinion of the owner

Question 57

Negotiation considerations (2)

Answer 57

- Value in use | - Replacement cost (cost of setting up business from scratch)

Question 58

Finance theory assumes

Answer 58

Investors behave rationally

Question 59

Factors that impact overvaluation problem (3)

Answer 59

- Overconfidence - Herd behaviour - Availability bias

Question 60

Availability bias

Answer 60

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

Question 61

Irredeemable instruments

Answer 61

Treat as a perpetuity

Question 62

Redeemable instruments

Answer 62

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

Question 63

Intangible assets

Answer 63

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