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Corporate Strategy And Valuation > Topic 3 > Flashcards

Topic 3 Flashcards

1
Q

What do DCF models view

A

intrinsic value of a common stock as the present value of its expected future CF

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2
Q

Name 3 different DCF models

A
  1. DDM
  2. FCF model
  3. Residual Income model
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3
Q

What is the rationale of DDM

A

During an investors holding period, he generally receives cash returns only in the form of dividends

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4
Q

What is the argument against DDM

A

Value should be driven by earnings but not dividends

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5
Q

what is the relationship b/w earnings and dividends

A
  1. Reinvested earnings provide a basis for increased future dividends
  2. Dividend displacement of earnings; a higher payout ratio now may imply a slower growth rate in the future
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6
Q

what the the formula for dividend payout ratio

A

1-b

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7
Q

what is the formula for growth rate

A

g = b * ROE

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8
Q

What should you consider when choosing a DDM

A
  1. History of dividend payment
  2. Do the dividends have a consistent relationship to the company’s profitability
  3. Does the investor take a non-control perspective
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9
Q

What model do you use if there is constant growth forever

A

gordon growth model

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10
Q

what dividend model do you use if theres 2 stages of growth

A
  1. Two-stage growth model

2. H-model involving a linearly declining growth rate

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11
Q

what dividend model do you use if there is three stages of growth

A
  1. Three-stage growth model with three distinct growth

2. three-stage growth model involving H model

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12
Q

what is the formula for GGM

A

D1/ r-g

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13
Q

What are the limitations of GGM

A
  1. Stock value is sensitive to r and g
  2. not applicable to non-dividend paying companies
  3. g must be constant
  4. underlying assumption r > g
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14
Q

What does it mean when

Expected g ><= implied g

A
  1. Undervalued
  2. Overvalued
  3. Fairly valued
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15
Q

How do you value a preferred stock

A

D0/r

as g = 0

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16
Q

What is trailing and leading P/E ratio

A

P0/E0

P0/E1

17
Q

an alternative perspective on the valuation of the stock is

Justified P/E >=< actual P/E

A

Undervalued
Fairly Valued
Over Valued

18
Q

What is the formula when using GGM to derive justified leading P/E

A

(1-b)/r-g

19
Q

What is the formula when using GGM to derive trailing leading P/E

A

(1-b)(1+g)/r-g

20
Q 
Stock price $50.00
Trailing earnings per share $4 .00
Current dividends per share $1.60
Dividend growth rate
5%
Required return on stock 9%

Use GGM to calculate justified leading P/E

A

(1.6/4)/0.09-0.05 = 10

21
Q 
Stock price $50.00
Trailing earnings per share $4 .00
Current dividends per share $1.60
Dividend growth rate
5%
Required return on stock 9%

Use GGM to calculate justified trailing P/E

A

10*1.05 = 10.5

22
Q 
Stock price $50.00
Trailing earnings per share $4 .00
Current dividends per share $1.60
Dividend growth rate
5%
Required return on stock 9%

evaluate the stock ? overvalued, undervalued or fairly valued

A

Calculate actual trailing P/E = 50/4 = 12.5 > 10.5 therefore its overvalued

or

Calculate GGm 1.6*(1.05)/0.09-0.05 = 42 < 50 therefore its overvalued

23
Q

What are the strengths of GGM

A
  1. Simple to understand
  2. Applicable to stable, mature firms that have constant dividend growth
  3. Can be applied to entire markets
  4. g can be estimates using macro data ie nominal GDP growth
  5. Can be applied to firms that repurchase stock
24
Q

What is the formula for g

A

g = (1 - modified payout ratio) * ROE

Modified Payout ratio = Dividends+ stock buybacks/ net income

25
Q

What are the assumptions of the fast growth stage

A

Rapidly increasing earnings
Heavy reinvestment
Small or no dividends

26
Q

what are the assumptions of the transition stage

A

Growth slows
capital reinvestment slows
FCFE and dividends Increase

27
Q

What are the assumptions of the maturity stage

A

ROE = r
Earnings and dividends growth matures
GGM useful

28
Q

what stages are needed for the general two stage model

A

Fast growth stage and maturity stage

29
Q

What are two ways to determine the terminal value Pt

A

Apply GGM to estimat Pt = Dt+1/r-gl
Or
Apply a multiple to Pt
Pt = forecasted earnings*P/E

Forecasted earnings = D/1-b

30
Q

how do you estimate growth rate at mature stage

A 
g = b*ROE
ROE = required return = industry average

g = (NI-Div/NI)* Ni/Sales * Sales/TA * TA/Equity

Corporate Strategy And Valuation (7 decks)

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