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Valuation Flashcards

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1
Q

What is valuation?

A

Present value of future cash flows of an asset

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2
Q

What is the discount rate used for valuation?

A

The required rate of return that the investors requires given the environment in which the investment is made. It can be determined by the return in similar assets trading on the market.

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3
Q

How do you value non redeemable debentures and bonds?

A

Non redeemable debentures = perpetuity

PV= CF1 / I/Y

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4
Q

What is yield to maturity?

A

Implicit return that an investor will earn by holding the bond or debenture until maturity. It is also known as the internal rate of return(IRR).

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5
Q

How do you calculate the present value of redeemable debentures?

A

Two types of cash flows:
- periodic interest
- repayment of capital at redemption date
Therefore, PV of interest + PV capital

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6
Q

What is the present value of non redeemable preference shares?

A

Perpetuity - PV= CF1 / I/Y

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7
Q

What is the present value of cumulative preference shares in arrear?

A

Step1: add all the missed dividends in the year that is will be paid
Step 2: calculate the value do perpetuity of the preference share on the year the arrear dividends will be paid
Step 3: sum up
Step 4: discount it back to present value using the required rate of return

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8
Q

What is the present value of non cumulative preference shares with dividend passed?

A

Step 1: calculate the value of perpetuity of preference shares at the end of the year that the dividend will be received
Step 2: add the dividend for that year
Step 3: discount back to present value using the required rate of return

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9
Q

What is the present value of redeemable preference shares?

A 
Similar to redeemable debentures.
Step 1: calculate the PV of dividends
Step 2: calculate the PV of capital
Step 3: sum up 
Or 
Financial calculator
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10
Q

What is the valuation of ordinary equity?

A

Present value of future cash flows (dividends)

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11
Q

What are some methods used for valuation of ordinary equity?

A
  1. Dividend discount/growth model and Earnings yield
  2. Price multiples ( PE ratio or EY)
  3. Free cash flow method
  4. Economic value added (EVA)
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12
Q

How do you calculate using dividend growth model?

A 
PV = CF1 + growth / I/Y - growth
PV = next dividend / (required rate of return - growth)
PV = (EPS + growth) / (required rate of return - growth)
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13
Q

What is downfall of dividend growth model?

A
  1. Assumes growth is constant

2. Applicable only where the required rate of return is higher than the growth rate

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14
Q

When do you use the dividend growth model?

A

When valuing a firm with steady growth, operating in a mature industry sector.

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15
Q

How do you value a firm with a non constant growth rate?

A

Using two stage valuation method

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16
Q

How do you perform a two stage valuation?

A

Step 1: calculate the PV of dividend until the growth rate changes
Step 2: value the growing perpetuity in the date the growth rate changes
Step 3: discount back to present value using the required rate of return
Step 4: sum step 1 and step 3

17
Q

When do you use price multiple?

A

To determine whether the shares are over or under valued
These are useful for valuing unlisted companies, as you can use PE or EY of a comparable listed company and adjust according to its specific risk factors.

18
Q

What is the PE ratio?

A

It measures the relationship between the company’s earnings per share and the share price
PE = EPS/ price per share
It shows how may times the investors are prepared to pay for a firm’s earnings per share

19
Q

How do you know using the PE ratio that a share is under or over valued?

A

Compare the PE of a firm to sector’s average PE
If company’s PE is lower than its undervalued
If company’s PE is higher than it is overvalued

20
Q

When will a company have a high PE ratio?

A

When it is experiencing high growth rate in earnings

When a company has low financial leverage to reflect the lower risk profile

21
Q

What is earnings yield?

A

Earnings yield is the inverse of PE ratio
So if PE is 9
EY is 0.09

22
Q

What is market to book ratio?

A

Also known as the net asset value per share

It is the share price of a company to the company’s book value per share.

23
Q

How do you calculate the market to book ratio?

A

Share price / book value per share

Book value per share = shareholders equity / number of ordinary shares

24
Q

How do you calculate price to sale ratio?

A

Price to sale ratio= sales per share / share price

25
Q

List the 10 steps approach to valuation.

A
  1. Purpose of valuation
    • for whom
    • for what reason
    • limitations
  2. Date of valuation
  3. What is being valued? And size of interest
  4. Interested parties
    • who do you represent?
  5. Decide in suitable method
    • dividends yield
    • net asset value (liquidation or going concern)
    • earnings yield
    • free cash flow
  6. Calculate the expected future sustainable earnings or dividends
    • sustainable income = net income after tax adjust for unusual items
  7. Determine reasonable rate of return
    • use listed company and adjust for risk factor
  8. Carry out the valuation
  9. Test for reasonability
    • perform valuation using different method
    • provide reason if its reasonable
  10. Conclusion
26
Q

When do you use the dividend yield method for valuation?

A

Company shows a reasonable return on their asset and the investment is a majority interest with evidence of growth.

27
Q

When do you use earnings yield?

A

When the investment has a fluctuation in its annual cash flows with evidence for growth, and the investment is a majority interest

28
Q

When do you use net asset value?

A

When the value of the company lies in the financial position.
If the company is going concern then you would use the going concern basis if its not a going concern then you would use liquidation basis (asset stripping)

29
Q

What are some reasons for adjustment in income to reflect reasonable future sustainable income?

A
  1. Exceptional items which are non recurring
  2. Over provision or under provision
  3. Changes in accounting policy
  4. Transactions that do not occur in the normal course of business
  5. Higher or lower reasonable/market compensation to employees or directors
  6. Higher or lower finance costs
  7. Inflation
  8. Profit or loss on sale of assets or investment
  9. Changes in statutory tax rate
30
Q

What are some of the adjustment factors for required rate of return?

A
  1. Share of listed co are more easily traded
  2. Shareholders agreement limits the transferability of private co
  3. Funds are readily available for listed co
  4. Shares of listed co are more acceptable as security for financial institutes
  5. Nature of product marketed(luxury or necessities)
  6. Competence of management
  7. Size of company (larger are better cope with economic downturns)
  8. Age of the company
  9. Financial risk (gearing and ability to raise additional finance)
    6.

Finance (12 decks)

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