Valuation Flashcards
You use dividends as returns when… (3)
The company is dividend paying
There is a dividend policy
Investor takes a non-control perspective
4 basic steps in valuation
- Selecting a specific definition of returns
- Forecasting the cash flow
- Choosing the discount rate
- Discounting the cash flows to the present
Gordon Growth Model assumption
dividends grow indefinitely at a constant rate, model is only valid when r > g, market’s implied growth rate can be calculated by substituting the values of V0, D0 and r
Two-stage dividend discount model stages (2)
Stage 1 - presents a period of abnormal growth at a constant rate
Stage 2 - assumes a constant growth rate
H Model assumptions (2)
growth rate is assumed to decline from an abnormal rate to the mature growth rate during stage 1, stage 2 assumes a constant growth rate
CAPM assumptions (3)
Investors are risk averse
Investment is based on a mean return and variance of total portfolio
Relevant risk is systematic risk
Dividend models are most appropriate for…
mature, profitable, dividend paying firms
Gordon Growth model applicable for…
mature, stable firms
Use free cash flow as return when… (4)
company is not dividend paying
company is paying dividend but differs significantly from FCFE
FCF and profitability are aligned
investor takes a control perspective
FCFF is…
cash flow available to all firm capital providers
FCFE is…
cash flow available to common equity holders
FCFF is preferred when…
FCFE is negative or there is an unstable capital structure
Discount FCFF with…
WACC
Discount FCFE with…
required return on equity
Equity Value =
PV(FCFF) - debt value
Adjustments need to be made to FCFF and FCFE for…
non cash events
Use residual income as a return when… (2)
company is not dividend paying
Expected FCFs are negative within the forecast horizon
Strengths of the RI model (6)
less weighting on TV
uses available accounting data
useful for non-dividend paying firms
useful for firms without FCF
useful when cash flows are unpredictable
based on economic value
Weaknesses of the RI model (4)
relies on accounting data
may require adjustments to accounting data
relies on clean surplus relation
assumes that cost of debt (Rd) = interest expense
