Prelim Exam Reviewer Flashcards
pertains to the worth of an object in another person’s point of view
Value
it is the estimation of an asset’s value based on variables perceived to be related to future investment returns, on comparisons with similar assets, or when relevant, an estimates of immediate liquidation proceeds.
Valuation
“A company creates value if and only if the return on capital invested exceed the cost of acquiring capital”
Marshall’s Principle on Creating Value
3 Major Factors That Can Be Linked to The Value of Business
- Current operations
- Future prospects
- Embedded risk
How is the operating performance of the firm in recent year?
Current operations
what is the long term, strategic direction of the company?
Future prospects
what are the business risks involved in running the business?
Embedded risk
the value that’s an investor considers on the basis of an evaluation of available facts, to be the “true” or “real” value.
Intrinsic value
the price of an asset when buyer and seller have reasonable knowledge of it and are willing to trade without pressure
Fair market value
the net value of a company’s physical assets if it were to go out of business and the assets sold
Liquidation value
the value of a company under the assumption that it will continue to operate for the foreseeable future.
Going-concern value
the process of making strategic decisions about how to invest and manage a collection of assets or investments, known as a portfolio, to achieve specific financial goals while balancing risk and return
Portfolio management
For fundamental analysts, the true
value of firm can be estimated by
looking at its financial characteristics,
its growth prospects, cash flows and
risk profile.
Fundamental analyst
tend to look for companies with good
growth prospects that have poor
management.
Activist investors
usually do “takeovers”
Activist investors
relies on the concept that stock prices
are significantly influenced by how
investors think and act
Chartists
correlate value and how information will affect this value.
Information traders
Under Portfolio Management, The Following Activities Can Be Performed Through the Use of Valuation Techniques
Stock selection
Deducing market expectations
is a particular asset fairly priced,
overpriced, underpriced in relation to
its prevailing computed intrinsic value
and prices of comparable assets
Stock selection
which estimates of a firm’s future
performance are in line with the
prevailing market price of its stocks?
Are there assumptions about
fundamentals that will justify the
prevailing price?
Deducing market expectations
general term which describes the
transaction wherein two companies had their assets combined to form a wholly new entity.
Merger
sale of a major component or
segment of a business to another company
Divestiture
separating a segment or component
business and transforming this into a separate legal entity
Spin-off
Acquisition of another business by
using significant debt which uses the acquired business as a collateral.
Buyout
Valuation in deals analysis consider two important, unique factors
Synergy
Control
potential increase in firm value that
can be generated once two firms merge with each other
Synergy
change in people managing the
organization brought about by the acquisition
Control
small private businesses that need
additional money to expand use
valuation concepts when approaching
private equity investors and venture
capital providers to show the promise
of the business
Corporate finance
Large companies who wish to obtain
additional funds by offering their
shares to the public also need valuation to estimate the price they are going to fetch in the stock market
Corporate finance
ensures that financial outcomes and corporate strategy drives maximum of firm value
Corporate finance
if a new partner will join a
partnership or an old partner will retire, the
whole partnership should be valued to identify
how much should be the buy-in or sell-out
Legal and tax purpose
Issuance of a fairness opinion for
valuations provided by third party
Other purpose
Basis for assessment of potential
lending activities by financial
institutions
Other purpose
Share-based payment / compensation
Other purpose
5 STEPS VALUATION PROCESS
Understanding of the business
Forecasting financial performance
Selecting the right valuation model
Preparing valuation model based kn forecasts
Applying valuation conclusions and preparing recommendation
includes performing industry and
competitive analysis and analysis of
publicly available financial
information and corporate disclosures
Understanding of the business
refers to the
inherent technical and economic
characteristics of an industry and the
trends that may affect this structure
Industry structure
means that these are true to most, if not all, market player participating in that industry
Industry characteristics
Porter’s 5 forces model
Rivalry among existing competitors
Threat of new entrants
Threat of substitutes
Bargaining power of buyers
Bargaining power of suppliers
Porter’s generic strategies
Cost leadership
Differentiation
Focus
pertains to the method how
the company makes money - what are the
products or services they offer how they deliver
and provide these to customers and their target
customers
Business model
Typical sources of information
- government-mandated disclosures like
audited financial statements - regulatory filings, company press releases
and financial statements - news articles
- reports from industry organization
- reports from regulatory agencies
- industry researches done by independent
firms
FORECASTING FINANCIAL
PERFORMANCE
Can be looked at two lenses
Macro perspective
Micro perspective
forecast starts from international or national
macroeconomic projections with utmost
consideration to industry-specific forecasts
Top-down forecasting approach
common variables include GDP forecast,
consumption forecasts, inflation projections,
foreign exchange currency rates, industry sale
and market share.
Top-down forecasting approach
forecast starts from the lower levels of the firm
and is completed as it captures what will happen
to the company based on the inputs of its
segment/units.
Bottom-up forecasting approach
The appropriation valuation model will
depend on the
context of the valuation
inherent characteristics of the company being
valued
once the valuation model is decided, the
forecasts should now be inputted and converted
to the chosen valuation model.
Preparing valuation model based on forecasts
assumptions that are commonly used are sales
growth, gross margin rates and discount rates.
Aside from these, other variables (like market
share, advertising expense, discounts,
differentiated feature, etc)
Sensitivity analysis
These factors that do not affect value per share
when analysts only look at core business
operations but will still influence value
regardless. This includes control premium,
absence of marketability discount and
illiquidity discounts.
Situational adjustments or scenario modeling
SIX KEY PRINCIPLES IN VALUATION
The valuation of a business is defined only at a specific point in time.
Value varies based on the ability of
business to generate future cash flows
Market dictates the appropriate rate
return for investor
Firm value can be impacted by underlying net tangible assets.
Value is influenced by transferability of
future cash flows
Value is impacted by liquidity
Refers to the possible range of values where the real firm value lies.
Uncertainty
is captured in valuation models through cost of capital or discount rate.
Uncertainty
as transactions that would yield future
economic benefits as a result of past
transactions.
Assets
is highly dependent on the value that the assets will generate from now until the future
Value of investment opportunities
a sensitive and
confidential activity in the portfolio
management.
Valuation
value shall be based on pure estimates
and these are investments that started
from scratch
Green field investment
investments are already in the going
concern state
• considered as Going concern Business
Opportunities (GCBOs).
Brown field investment
Advantage of brownfield investment:
already have a reference for their
performance-from its historical performance or
an existing business with similar nature.
suggests
that risk management principles must be
observed in doing businesses and determining
its value.
The Committee of Sponsoring Organization of the Treadway Commission (COSO)
is dependent on the economic
benefits. (i.e., cash flows) it gives.
Asset value
Advantage and disadvantage of asset value
Advantage: It enables the analyst to validate
the firm value through the value of its assets.
Disadvantage: that it only focuses on the
current and historical value of the assets and
will disregard the value it can generate in the
future and may not fully represent the true
value of the assets
value recorded in the accounting
records of a company. It is highly
dependent on the value of the assets as declared in the audited financial
statements.
Book value method
expected to be realized within the
company’s normal operating cycle.
• realized within 12 months after these
transactions were reported, or held
primarily for the purpose of trading
Current assets
are the assets wherein benefits can be
realized in more than 12 months
• Benefits can be realized in more than
12 months
Non current assets
are expected to be settled within the
entity’s normal operating cycle
• settled within 12 months, held for the
purpose of trading or if the company
does not have ability to settle beyond
12 months.
Current liabilities
due to be settled longer than 12
months
No current liabilities
True or false:
The Value of the enterprise is based on the book value of the assets less all non-equity claims against it.
True
Pros and cons of bv method
Advantage: of using book value method is that
It provides a more transparent view on firm
value and is more verifiable since this is based
in the figures reflected in the financial
statements.
Disadvantage: Book value only reflects
historical value and might not reflect the real
value of the business now. It does not account
for the full value of the net assets now that would
result for overage or understatement of value of
the net assets recorded in the book
the cost of similar assets that have the nearest equivalent value as of the valuation date. Under The replacement value method, the value of the individual assets shall be adjusted to reflect the relative value or cost equivalent to replace the asset.
Replacement cost - National Association of Valuators and
Analysts
This will enable the valuator to
determine the costs related in order to
upkeep similarly aged assets and
whether assets with similar engineering design are still available in the market.
Age of the asset
This is important for fixed assets
particularly real property where assets
of the similar size will be compared.
Size of the assets
Assets which have distinct
characteristics are hard to replace.
Some valuators combine the value of
the similar, separate assets that can
perform the function of the distinct
asset being valued.
Competitive advantage of the assets
The basis for replacement cost of assets that are highly specialized in nature. In this case, reproduction value is used instead.
Reproduction value method
is an estimate of cost of producing,
creating, developing, or manufacturing
a similar asset.
• This method requires reproduction cost analysis
Reproduction value method
is an equity valuation approach that considers the salvage value as the value of the asset.
Advantage: It provides is the most
conservative value.
Disadvantage: The future value is not fully incorporated in the calculated equity value.
Liquidation value method
is a company’s calculation of the
minimum return that would be necessary in order
to justify undertaking a capital budgeting project.
Cost of capital
represents the cost a company incurs when it borrows money through
loans or by issuing bonds. This cost is essentially the interest rate the company pays to its
creditors (lenders or bondholders) for using their money.
cost of debt
represents the return that shareholders (owners) of a company expect
for investing their money in the business. It is the return required by equity investors to
compensate them for the risk associated with owning shares in the company.
cost of equity
is a tool to calculate the overall cost of financing by
considering both debt and equit
Weighted Average Cost of Capital (WACC)
Measures a company’s cost to borrow money given the
proportional amounts of each type of debt and equity a
company has taken on.
WACC
10% return, 8% WACC - creates value
10% return, 15% WACC - destroys value
10% return, 10% WACC - stagnant value
Ohaha HAHAHHA
It refers to the overall health and performance of the economy at a
given period of time. They determine the demand and supply of
capital within the economy, as well as the level of expected
inflation.
General economic conditions
the level of interest rates set by the central banks
directly affects the cost of capital.
Interest rates
Inflation erodes the purchasing power of money
progressively.
Inflation rates
A strong economy with robust growth can lead to higher demand
for capital, which possibly drives up the cost of capital as businesses compete for
funds
Economic growth
Economic downturns can lead to risk aversion, possibly
increasing the cost of capital as investors demand for higher returns to
compensate for perceived risks
Market Segment
also determine the demand and supply of capital, as well as
investor sentiment and overall market volatility
Market Conditions
Market conditions determine the
availability of capital. Where there is a high demand for
funds, the cost of capital may rise due to the increased
competitions between lenders.
Demand and Supply -
this can also influence the cost of
capital in a way optimistic sentiment can lead to higher stock
prices and lower expected returns, possibly reducing the cost
of capital.
Investor Sentiment
Periods of high market volatility can
increase the perceived risk associated with investments
Market Volatility
this is determined by financing decision
that involves the mix of debt and equity used to fund its
operations.
Capital Structure
can affect the company’s probability
and cash flows.
Operating Efficiency
this is a part of financing decisions. A more
generous dividend policy may attract certain investors but can also
increase the cost of equity capital, as shareholders expect higher
returns.
Dividend Policy
the risk and return profile of these
investments can influence the cost of capital in a way where
high-risk projects may require a higher expected return.
Investment Choices
the total amount of financing a company requires for its
operations, projects, or expansion plans.
Scale of Financing
the amount of financing sought can affect the perceived risk of the
investment
Risk and Return
