Session 12 - Equity Valuation Models

Question 1

Free Cash Flow to the Firm (FCFF) - Qualitative

Answer 1

$ available to all of the firm’s investors, including stock and bondholders, after the firm buys and sells products, provides services, pays its cash operating expenses and makes short and long-term investments.

Question 2

Free Cash Flow to Equity (FCFE) - Qualitative

Answer 2

The $ available to common shareholders after funding capital requirements, working capital needs, and debt financing.

Question 3

1. Firm Value versus 2. Equity Value

Answer 3

1. FCFF discounted at the WACC

2. FCFE discounted at the required return on equity. OR, firm value - mkt value of debt

Question 4

1. Trailing P/E versus 2. Leading P/E

Answer 4

1. Mkt price per share / EPS over previous 12 months

2. Mkt price per share / Forecasted EPS over next 12 months

Question 5

1. Trailing Dividend Yield (D/P)

2. Leading Dividend Yield (D/P)

Answer 5

1. (4 x most recent quarterly dividend) / mkt price per share
2. Forecasted dividend over next 4 quarters / mkt price per share

Question 6

Enterprise Value (EV)

Answer 6

Measure of total company value
= mkt value of common stock
\+ mkt value of preferred equity
\+ mkt value of debt
\+ minority interest
- cash & investments

Question 7

Equity Charge

Answer 7

= equity capital x cost of equity

*This amount is removed from net income to get residual income.

Question 8

Economic Value Added (EVA)

Answer 8

NOPAT - (WACC x invested capital)

OR

[EBITx(1-t)] - $ cost of capital

Measures the value added for shareholders by management during a given year.

Question 9

Invested Capital

Answer 9

= NWC + net fixed assets

= BV of long-term debt + BV of equity

Question 10

Market Value Added (MVA)

Answer 10

Mkt value - invested capital

*measures the value created by management’s decisions since the firm’s inception.

Question 11

Forecasting Residual Income

Answer 11

RI(in year T) = Expected EPS in year T - (required equity return)(book value of equity in year T-1)…OR…
(ROE - required equity return)(book value of equity in year T-1)

Question 12

FCInv

Answer 12

= Capex - proceeds from sales of LT assets

Question 13

Capex

Answer 13

= Ending gross PP&E - Beginning gross PP&E

Question 14

WCInv

Answer 14

= change in working capital

Question 15

Calculate FCFF using statement of CF

Answer 15

= CFO + int(1-tax rate) - FCInv

*WCInv is already captured by CFO

Question 16

Calculate FCFF from EBIT

Answer 16

= [EBIT (1-tax rate)] + Dep - FCInv - WCInv

Question 17

Calculate FCFF from EBITDA

Answer 17

= [EBITDA(1-tax rate)] + (Dep x tax rate) - FCInv - WCInv

Question 18

Net borrowing

Answer 18

= long and short-term new debt issues - debt repayments

Question 19

Single-Stage FCFF Model

Answer 19

= (FCFF)(1 + g) / (WACC - g)

Question 20

Single-Stage FCFE Model

Answer 20

= (FCFE)(1 + g) / (r - g)

Question 21

PEG Ratio

Answer 21

= P/E ratio / g

*captures the relationship between earnings growth and P/E

Question 22

Discount for Lack of Control

Answer 22

= 1 - [1/(1 + control premium)]

Question 23

Residual Income

Answer 23

= Net income - Equity charge

Question 24

Single Stage Residual Income

Answer 24

V = Bv/share + (ROE - R)(Bv) / (r - g)