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F3 > Section C > Flashcards

Section C Flashcards

1
Q

What are the reasons an unlisted business valuation may be discounted by 25-35% ?

A
  1. Marketability of shares - less liquid market
  2. Degree of scrutiny - Poor quality financial information
  3. Perception that smaller company will be higher risk due to less reputible and may have unsteady earning records
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2
Q

What are the 3 basic ways of valuing a business when using Asset Valuation Model

A
  • Asset Based Valuation - More usable if purchasing Capital intensive business
  • Earnings Based Valuation - Forecasted earning times by certain number (number is agreed between parties)
  • Cashflow Based Valuation - Entity is valued at its future cashflow discounted at CoC
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3
Q

Under ABV what are the 3 ways assets can be calculated and briefly explain

A
  • Book value - but dependant on DEPN policy
  • Replacement value - What it would cost to replace or if you had to buy on the market to start new business
  • Net Reliasble/Break up - Best price possible but is dependant on the value of 2nd hand market
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4
Q

What are the Adv and DisAdv of Asset Based Valuation

A

Advantages

  • Easy and readily available
  • Minimum price a biz should be valued at

DisAdv

  • Based on value is SOFP so depends on A/c policy
  • Business valuation will include no amount for future expecations
  • Not suitable for business with Intangible Assets
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5
Q

CIV have additional drawbacks to those included in the ABV - what are they

A
  • Industry Avg return may not be suitable for valued business
  • CIV is calculated using Earnings so can be manipulated
  • Assumes future income is constant
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6
Q

What are the Adv and DisAdv of P/e ratio valuation method

A

Adv

  • Easy to understand and calculate (only 2 numbers needed)
  • Relevant for valuign a controlling interest in a business

DisAdv

  • Profit based
  • Difficult to find a relevant P/e ratio to use in the calculation
  • Difficult to establish relevant level of sustainable earnings
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7
Q

What does Cash Flow to Equity mean and what are the calculations

A

The value of the S/H stake (equity) in the entity, is then sum of the future free cashflows to equity discounted at the Cost of Equity

  • CF from Ops
  • Less I&T
  • Less Pref Div
  • Less Ongoing Capital Exp
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8
Q

Under Earnings Yield Method of business valuation, how do you calculate Value of business & share

A

Earning Yield = EPS/Share Price

EY Business Valuation = Total Earnings / EY

EY Value Per Share = EPS / EY

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9
Q

What is the best business valuation model to use when i want to asses:

  1. The controlling interest
  2. The minority interest
  3. The easiest valuation method
  4. The best valuation method
A
  1. CI = P/e ratio
  2. MI = DVM
  3. Easiest - P/e ratio
  4. Best - Discounted CF Method
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10
Q

What are the the Adv and DisAdv of DVM model

A

Adv

  • Value is based on future cashflows to the investor
  • Useful for valuing the minority interest in an entity

DisAdv

  • It can be hard to predict future dividens and growth about a business
  • If a business does not pay Div then it would be valued at Zero

Can be difficult to estimate a Ke (in particular a unlisted company)

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11
Q

‘The value of a business is the future post-tax cash flows of the business discounted at the appropriate CoC’

What business valuation model is this?

A

CF Valuation - Discounted CF Method

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12
Q

How would you define the CF Method DVM?

A

Value of the business/share is the present value of the future divdends discounted at the investors rate of return

Therefore, if we assume all FCF to equity are paid as dividend then this would be the same as valuing a company by discounting FCF to equity and the Ke

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13
Q

What discount rate should be used when looking at

  1. FCF to Investors
  2. FCF to Equity
A
  1. FCF to Investors (Post Tax CF BEFORE financing) = WACC
  2. FCF to Equty (Post Tax CF AFTER financing)
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14
Q

What are the Adv and DisAdv of CF Valuation method DCF

A

Adv

  • Best to use
  • Considers Time Value of Money
  • Gives a maximum price of entity

DisAdv

  • Discount rate is hard to determine
  • CF are hard to forecast accurately
  • Assumes Tax and Discount Rate are contstant for the period
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15
Q

What is CAPM used for?

A

Enables us to calculate the the Required Rate of Return from an investment given the level of risk associated (measued by it Beta)

This will be for a well diversifed investor who is not subject to Unsystematic Risk

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16
Q

Explain the Beta Factor

A
  • Beta Factor is the measure of systematic risk in relation to the market as a whole
  • The risk will be dependant on the Business Risk (in which in operates) and Financial Risk (gearing)
  • Beta factor for a geared company will be greater than equivilant ungeared company
17
Q

Explain the values

B = >1

B = 1

B = <1

B=0

A

B >1 - Investment has more systematic risk than the market avg

B= 1 - Investment has same systematic risk than the market avg

B<1 - Investment has less systematic risk than the market avg

B=0 - Investment has no risk at all

18
Q

Explain:

Risk Free Security and its Beta Factor

The Market Portfolio and its Beta Factor

A

RFS = The investment has no risk at all and its B = 0

TMP = Ultimate diversification and therefore only has systematic risk. B = 1

19
Q

Explain the Alpha Values when looking at CAPM

A

Alpha Values is simply the average abnormal rate of return. It can be + or - a certain % from the CAPM

e.g.

If CAPM was 16% and Alpha Value was +2%

The average Rate of Return would be 16+2%

20
Q

Give 5 examples of criticisms of CAPM

A
  1. Only calculated for single period and will therefore need to be updated regulary
  2. Assumes no transaction costs assocated with trading shares
  3. Any beta value used will be on historic basis and will become invalid if the entity changes capital structre or business risk
  4. Risk free rate may change over short periods of time
  5. Assumes it can diversify away risk. Not always possible
21
Q

What is the concept of FCF to equity

A

CF available for distribution to Investors after the entity has made all investments in NCA and Working Cap needed for ongoing Ops.

FCF to equity is therefore found by deducting Interest (financing charges) from the free cashflow to investors

22
Q

Explain what we are doing when we use the Asset Beta formula for ungearing a business

A

We use the proxy companies Beta factor to split it up between Business Risk and Finacial Risk

If Bg = 1.45

and Bu = 1.07

This means that S/H have a Systematic risk of 1.45 of which 1.07 relates to Business Risk and the balance is the Finacial Risk caused my Capital Structure

23
Q

What are the key points about Equity and Asset Beta (Ungeared Beta)

A

Equity Beta will always be higher than Asset Beta except if:

Company is all equity based when both will be the same

Companies operating in same industry will have the same Asset Beta

Companies will have different Equity Beta unless they have the same Capital Structure

24
Q

We use DVM to look at minority interest as this will be the cash flows the the investor

DFM Method is best used for the majority interest as it reflect all the future cashflows of the business

A

F3 (7 decks)

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