Week 4 - Discounted cash flow (DCF) Valuation Models

Question 1

What is the difference between passive and active investment?

Answer 1

Passive:

Markets are efficient

Investors cannot achieve higher returns than the equilibrium ones

Strategy: buy and hold long term

Active:

Markets are inefficient

There are mispriced securities

Strategy: Buy, hold, sell (short term)

Question 2

Difference between fundamental and technical analysis?

Answer 2

Fundamental analysis postulates that a security has an intrinsic value

Technical analysis provides some insight into market psychology. (therefore aim to identify trends at an early stage).

Question 3

What is the return on any asset?

Answer 3

Question 4

How much is the asset worth today?

Answer 4

Question 5

Formulae to identify price based on Discounted Cash flow?

and what is the components of the discount rate?

Answer 5

Question 6

Purpose of DCF models?

Answer 6

Question 7

Formulaes for zero growth models?

Answer 7

Question 8

Formulaes of constant growth models

Answer 8

Question 9

Three-stage growth example

Answer 9

Question 10

What is the formulae for future earnings?

And what is the assumption?

Answer 10

Question 11

What is the first formulae for growth? (simplest one)

Answer 11

Question 12

What is b?

And how is it calculated? (two formulas)

Answer 12

• The Retention rate
• either by isolating it from the g formulae or by:

b=(net income - dividens)/net income

or

b= 1 - dividend payout ratio = 1 - (dividend / EPS)

Question 13

What is ROE?

How do you calculate it?

Answer 13

• Return of Equity
• either by isolating it from the g formulae or by:

ROE= net income/ equity

Question 14

What is the second formulae for calculating g?

Answer 14

Question 15

What are the earning multipliers?

What is the two ways of identifying/estimating it?

Answer 15

• P/E
• Trailing or leading P/E

Question 16

What is trailing P/E?

Answer 16

Question 17

What is leading P/E?

Answer 17

Question 18

What is the formulae for trailing?

Answer 18

Question 19

What is the formulae for leading P/E?

Answer 19

Question 20

Do the relative valuation example

Answer 20

Question 21

Where does the term sustainable growth come from?

Answer 21

It stems from the assumption that all investments are funded by retained earnings and not issues of new equity

Question 22

Explain the difference between DCF models and price multiples?

Answer 22

DCF are designed to estimate the intrinsic value of stock, whereas the multiples asses the current stock price - on a relative basis