46 Equity Valuation

Question 1

Types of Equity Valuation

Answer 1

1) Discounted cashflow model
2) Multiplier model
3) Asset-based models

Question 2

Discounted cash flow

Answer 2

Estimated value of the PV of future cash

Question 3

Dividend discount model

Answer 3

Future cash distributed to shareholders

Question 4

Free cash flow to equity model

Answer 4

Future cash available to shareholders

Question 5

Multiplier models

Answer 5

1) Price multiplier
2) Enterprise value multiplier

Question 6

Asset-based model

Answer 6

Equity value is equal to total asset value minus liabilities and preferred stock values

Question 7

Cash dividends

Answer 7

Payments made to shareholders in cash
1) Regular dividends
2) Extra (special) dividends

Question 8

Stock dividend

Answer 8

Payment to shareholders in shares of stock

Question 9

Stock split

Answer 9

Proportionate increase in shares outstanding

Question 10

Reverse stock split

Answer 10

Proportionate decrease in shares outstanding

Question 11

Share repurchase

Answer 11

1) Tax advantage (if capital gains tax lower than dividend tax)
2) Signal that shares are undervalued
3) Can offset employee stock options

Question 12

Dividends: Declaration date

Answer 12

Date board approves dividend

Question 13

Dividends: Ex-dividend date

Answer 13

First day stock trades without dividend.

Question 14

Dividend: Holder of record date

Answer 14

Date shareholders must own to receive dividend

Question 15

Dividend: Payment date

Answer 15

Date checks are mailed to funds transferred.

Question 16

Dividend discount model

Answer 16

V = \sum (D/ (1+k)^t)

Question 17

Free cash flow to equity model formula

Answer 17

V = \sum (FCFE/ (1+k)^t)

Question 18

Free cash flow to equity model

Answer 18

Cash available after a firm meets its debt obligations and necessary capital expenditures

Question 19

FCFE model rationale

Answer 19

1) Reflects firm’s capacity to pay a dividend
2) This model is useful for firms that currently do not pay a dividend
3) Analyst does not have to project the amount and timing of future dividend payments

Question 20

Gordon (Constant) Growth Model

Answer 20

V = D / (k - g)

Question 21

Estimating g in Gordan growth model

Answer 21

g = RR * ROE

where,
RR = earning retention ratio or (1- dividend payout ratio)

Question 22

Multi-stage DDB

Answer 22

1) For companies experiencing temporary rapid growth
2) Assumes dividend growth will be constant at some future date

Question 23

Multi-stage DDM method

Answer 23

1) Estimate dividends during growth period
2) Find terminal value using Gordan Growth model
3) Find PV of expected dividends and expected future stock price

Question 24

Gordon growth model use

Answer 24

1) Stable and mature firms
2) Non-cyclical firms

Question 25

2-stage DDM use

Answer 25

1) Firms with high current growth that will stabilize in the future 2) Older firms that were in the constant growth phase but are losing market share

Question 26

3-stage DDM

Answer 26

Young firms in the high growth phase

Question 27

Common price multiples for comparables

Answer 27

1) Price to earnings 2) Price to cash flow 3) Price to sales 4) Price to book value

Question 28

Advantages of price multiple approach

Answer 28

1) Widely used 2) Readily available 3) Easy to calculate 4) Can be used for cross-sectional analysis or time series analysis 5) Associated with equity returns

Question 29

P/E Based on Fundamentals

Answer 29

P0/E1 = D1/E1/(k-g) Higher if, 1) Higher dividend payout ratio 2) Higher growth rate 3) Lower required return

Question 30

Price multiples

Answer 30

1) P/E 2) P/S 3) P/B 4) P/CF

Question 31

Law of one price

Answer 31

Two comparable assets should sell for the same multiple

Question 32

Enterprise Value Multiple

Answer 32

EV/ EBITDA

Question 33

Enterprise value

Answer 33

MV of Stock + MV of Debt - Cash

Question 34

EV multiple use

Answer 34

1) Firms have different capital structures 2) Earnings are negative (i.e. can't use P/E ratio)

Question 35

Asset based models

Answer 35

1) Equity equals FV of assets less liabilities 2) Provides a floor value

Question 36

Present value model advantages

Answer 36

1) Theoretically sound 2) Widely accepted

Question 37

Present value model disadvantages

Answer 37

1) Inputs must be estimated 2) Valuation can be very sensitive to input values

Question 38

Mutliplier model advantages

Answer 38

1) Widely used, associated with stock returns 2) Easily calculated and readily available 3) Good for identifying attractive companies 4) Useful for time series analysis or cross-sectional analysis

Question 39

Mutliplier model disadvantages

Answer 39

1) Differences in accounting methods, comparisons 2) Multiples for cyclical companies highly variable.

Question 40

Asset based models advantages

Answer 40

1) Floor values 2) Useful for liquidation

Question 41

Asset based model disadvantages

Answer 41

1) Ongoing value maybe greater than asset value 2) FV of assets can be difficult to measure

Question 42

Choice of valuation model

Answer 42

1) The model should be chosen based on available inputs 2) The model should be chosen based on the intended use of the valuation 3) More complexity is not necessarily better 4) Consider values using more than one method 5) Consider uncertainty about input values 6) Consider uncertainty about model appropriateness