SS 14. Equity Analysis and Valuation

Question 1

Sustainable Growth Rate formula:

Answer 1

ROE * Retention Ratio

Retention Ratio = 1 - dividend payout ratio

Question 2

Dividend Discount Model (DDM):

Answer 2

Value of stock = Dividend per Share / (Discount rate - Dividend growth rate)

Question 3

Earnings Multiplier Model:

Answer 3

P/E = dividend payout ratio / (cost of equity - growth rate)

Question 4

Free Cash Flow (FCF) Model:

Answer 4

EBIT*(1-t) + depreciation + amortization - change in net working capital - capital expenditure

Question 5

DuPont Formula:

Answer 5

ROE = Profit Margin x Asset Turnover Ratio x Equity Multiplier.

Profit Margin = Net Income / Sales
Asset Turnover Ratio = Sales/Assets
Equity Multiplier = Assets/Equity

Question 6

3 Major Industry Classification Systems

Answer 6

1. GICS (Global Industry Classification Standard)
2. RGS (Russell Global Sectors)
3. ICB (Industry Classification Benchmark)

Question 7

4 stages of industry life-cycle:

Answer 7

1. Embryonic
2. Growth
3. Shake out
4. Mature/Declining

Question 8

Michael Porter’s 5 Forces:

Determinants of the intensity of competition in an industry

Answer 8

1. Threat of substitute products
2. Bargaining power of customers
3. Bargaining power of suppliers
4. Threat of new entrants
5. Intensity of rivalry

Question 9

Embryonic stage involves (4):

Answer 9

1. Slow growth
2. High prices
3. Significant Investment
4. High Risk

Question 10

Growth stage involves (4):

Answer 10

1. Rapidly increasing demand
2. Improving profitability
3. Falling prices
4. Low competition

Question 11

Shake out stage involves (3):

Answer 11

1. Slower growth
2. Intense competition
3. Declining profitability

Question 12

Mature stage involves (3):

Answer 12

1. Little or no growth
2. Industry consolidation
3. High barriers to entry

Question 13

Decline stage involves (3):

Answer 13

1. Negative growth
2. Excess capacity
3. High competition

Question 14

Cost of Equity =

Answer 14

(Dividends per Share [for next year]
/
Current Market Value of Stock)
\+
Divided Growth Rate

Question 15

The value of preferred stock is calculated as:

Answer 15

dividend / required rate of return

Question 16

EV (Enterprise Value) =

Answer 16

market value of common stock + market value of preferred equity + market value of debt + minority interest - cash and investments.

Question 17

Callable preference shares are (more/less) costly than non-callable preference shares

Answer 17

Less

Callable shares enable issuer to buy back shares

Question 18

Callable preference shares are (more/less) costly than putable preference shares

Answer 18

Less

Question 19

Which of the following measures is easiest to estimate?

A) The cost of debt

B) The cost of equity

C) Minimum required return on equity

Answer 19

A) The cost of debt

The cost of debt is easy to calculate as it reflects the predetermined interest (coupon) rate that the company will pay bondholders. The cost of equity is difficult to estimate due to uncertain cash flows.

Question 20

When would an analyst use asset-based valuation models to value a company?

Answer 20

When a company is not considered a going concern.

Question 21

Enterprise value is sometimes known as:

Answer 21

The cost of a takeover

Question 22

A disadvantage of the EV method for valuing equity is that the following information may be difficult to obtain:

Answer 22

Market value of debt

Question 23

Which type of equity valuation model is preferable when one is comparing similar companies?

Answer 23

A multiplier model

Question 24

Book Value of Equity =

Answer 24

Total assets - total liabilites

Question 25

The key elements of strategic industry analysis include (5):

Answer 25

Demographic influences

Government influences

Social influences

Technology influences

Life cycle of the industry