Valuation Flashcards
Define Long-Term Debt
Debt that matures in more than one year
Define Current Liabilities
Financial obligations that are paid off within 1 year
What is another word for Current Liabilities
short-term debt
Where are current liabilities listed?
In the current liabilities portion of total liabilities on the balance sheet
7 uses for short-term debt
- Accounts payable
- short term loans
- commercial paper
- lease payments
- taxes due
- salaries and wages
- stock dividends
Define Risk Adjusted Discount Rate
An estimation of the present value of cash for high risk investments
What is the formula for risk adjusted discount rate
Risk-adjusted discount rate = Risk free rate + Risk premium
Define Risk Free Rate
The theoretical rate of return of an investment with zero risk
What is the formula to calculate risk-free rate
(Risk Free Rate) = (Yield of Treasury bond matching investment duration) – (inflation rate)
Define Risk Premium
investment return an asset is expected to yield in excess of the risk-free rate of return
What is the formula to calculate risk-free premium
Risk premium= (Market rate of return - Risk free rate) x beta of the project
What is the use for Beta
Measure the volatility of a security, as it compares to the broader market
What does a Beta > 1 indicate? What does a Beta < 1 indicate? What does a Beta = 1 indicate?
> 1: Investment is more volatile (riskier) than the overall market
< 1: Investment is less volatile than overall market
= 1: Investment carries same risk as overall market
What is the average Market Rate of Return of the S&P?
10%
Define Cost of Equity
the compensation the market demands in exchange for owning the asset and bearing the risk of ownership
What are the 5 steps of DCF Valuation?
- Estimate discount rate or rates to use in the valuation
- Estimate current earnings and CFs on the asset
- Estimate the future earnings and CFs
- Estimate when the firm will reach “stable growth” and what characteristics it will have when it does
- Choose the right DCF model for this asset and value it
What is the difference between 10-K and 10-Q
10-Q is filed quarterly while 10-K is filed annually
Which cashflows are used in Firm Valuation and which in Equity Valuation?
Firm: Pre-debt cash flow
Equity: After debt cash flows
Which expected growth is used in Firm Valuation and which in Equity Valuation?
Firm: Growth in Operating Earnings
Equity: Growth in Net Income/EPS
Define Terminal Value
The point at which a firm is in stable growth and grows at a constant rate forever
Which Discount rate is used in Firm Valuation and which in Equity Valuation?
Firm: Cost of Capital
Equity: Cost of Equity
True/False: A company in terminal value has a growth rate less than or equal to the economy
True
Define “Free Cashflow to Equity”
The CF left over after every need has been met
Define “Free Cashflow to Firm”
The CF before debt has been paid
What does discount rate reflect?
Reflects the risk perceived by the marginal investor in the company
Define Marginal Investor
the investor most likely to be trading at the margin and has the most influence on the pricing of its equity
What are the three buckets of risks to use when determining Discount Rate
- Estimation vs. Economic Risks
- Micro vs. Macro risks
- Discrete vs. Continuous Risks
Define Estimation and Economic Risks
Estimation: Risks associated to you not doing your research and not collecting enough data
Economic: Risks outside your control like the FED raising interest rates
Define Micro and Macro Risks
Micro: Risks within a company (like who is running the company)
Macro: Risks outside the power of the company
Define Discrete and Continuous Risks
Discrete: Risks that lie dormant for periods but then show up at points in time
Continuous: Risks that occur periodically
