FM (Test) > F Theory > Flashcards

F Theory Flashcards

(56 cards)

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1
Q

Why is business valuation needed (private)

A

To determine the value of a private company

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2
Q

Why is business valuation needed (subsidiaries)

A

To value subsidiaries/divisions for possible disposal

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3
Q

Why is business valuation needed (decisions)

A

To aid in decisions on buying/selling shares in private companies

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4
Q

Types of information needed for a business valuation?

A

Financial statements
Budgets and forecasts
Summaries of working capital

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5
Q

Ways to value a share?

A

Asset-based valuations
Income based valuations
Cash flow-based valuations

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6
Q

Weakness of NBV (historical cost)

A

Balance sheet values (i.e. carrying amounts) are often based on historical cost rather than market values

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7
Q

Weakness of NBV (accounting policies)

A

Net book values of non-current assets depend on depreciation/amortisation policies

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8
Q

Weakness of NBV (unrecorded assets)

A

Significant assets may not be recorded in the statement of financial position (e.g. internally generated goodwill will not be recognised)

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9
Q

What is the net realisable value?

A

Estimated selling price less estimate costs necessary to make the sale

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10
Q

Weakness of NRV (Selling price)

A

Estimating selling prices under forced sale or distress conditions is challenging

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11
Q

Weakness of NRV (Market values)

A

The NRV of some assets may fluctuate significantly if they have volatile market values (e.g. commodities and financial instruments)

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12
Q

Weakness of NRV (Unrecorded)

A

It ignores unrecorded assets

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13
Q

What is net replacement cost?

A

The cost of setting up an identical business “from scratch”

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14
Q

Issues with net replacement cost (challenging to apply)

A

There may be no comparable replacement asset

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15
Q

Issues with net replacement cost (overvaluation)

A

Valuing old and less efficient assets at current market prices of new assets

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16
Q

Issues with net replacement cost (unrecorded assets)

A

It ignores unrecorded assets

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17
Q

What does the P/E ratio take into account?

A

The expected growth rate of that company

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18
Q

Weakness of P/E ratio (proxy)

A

A suitable “proxy” may not exist (i.e. no similar company listed on the stock market)

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19
Q

Weakness of P/E ratio (Accounting earnings are more subjective than cash flows)

A

Accounting earnings are affected by non-cash items (e.g. depreciation expense) and accounting policy choices

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20
Q

Weakness of P/E ratio (Earnings manipulation)

A

The earnings of the unquoted company may be intentionally inflated. The earnings may not represent future earnings fairly, even if they have not been deliberately distorted

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21
Q

Weakness of P/E ratio (Historical data)

A

The P/E ratio is often based on historical earnings, which may not reflect earnings potential. Share prices can sometimes vary dramatically.

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22
Q

What is earnings yield?

A

Simply the reciprocal of the P/E ratio

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23
Q

Problems with earnings yield (variability in yield)

Study These Flashcards
A

Earnings yield can vary significantly over time; it is not a stable valuation metric and it may be a challenge to interpret

24
Q

Problems with earnings yield (high interest rates)

Study These Flashcards
A

An earnings yield may appear attractive, but it may not be competitive compared to other investments when interest rates are high

25
Problems with earnings yield (non-earnings factor)
Other factors that may be important for investors are ignored (e.g. dividends, company management)
26
What is meant by constant dividend growth?
Dividends are forecast to grow at a constant annual rate to perpetuity
27
Weaknesses of dividend valuation model (Simplifying assumptions)
The constant growth rate assumption for dividends may not hold true for many companies in the long run, leading to inaccurate valuations
28
Weaknesses of dividend valuation model (sensitivity)
The valuation is highly sensitive to the choice of the required rate of return
29
Weaknesses of dividend valuation model (shareholder influence)
It has less relevance for valuing a majority shareholding, as an investor with control can change the dividend policy
30
Relevant cash flows for a business valuation?
The future operating cash flows, and the appropriate discount rate is the WACC
31
Why are DCF methods superior to non-DCF methods (intrinsic)
It considers the intrinsic value of a business based on its expected future cash flows
32
Why are DCF methods superior to non-DCF methods (TVM)
Allows for the time value of money
33
Disadvantage of DCF methods (Estimating challenges)
Estimating future cash flows and determining an appropriate discount rate can be complex and uncertain, especially for long-term forecasts
34
Disadvantage of DCF methods (Sensitivity to assumptions)
Small changes in assumptions about future cash flows and discount rates can lead to significantly different valuations
35
Disadvantage of DCF methods (Unpredictable cash flow)
A DCF-based valuation may be unsuitable for startups or high-growth companies with unpredictable cash flows
36
Issue with unquoted shares (stock market)?
Are not traded via the stock market, and this lack of marketability reduces their value relative to shares in quoted companies
37
Issue with unquoted shares (information)?
Much less information may be available for unquoted companies because they may not be required to publish accounts. Results in udnervaluation
38
What assumption is DVM given?
Perfect market
39
Issue of irrational investor behaviour?
Over-exuberance can lead to speculative bubbles
40
What is market capitalisation?
Refers to the total market value of a quoted company
41
Why is market capitalisation not necessarily the amount that needs paying for the company's entire equity?
The quoted share price is for a minority shareholding. A significant premium would usually have to be paid if control is required
42
What is the market paradox?
Investors must believe they are inefficient for markets to be efficient. If they thought them to be efficient, they would not buy or sell shares
43
What is meant by herding?
The desire to conform and not to act differently from others
44
What are noise traders?
Investors who do not base buy/sell decisions on rational analysis (i.e. without using fundamental data about the company's performance)
45
What is meant by loss aversion?
Avoid investments with the risk of making losses, even though expected value analysis suggests that, in the long term, they will make significant capital gains;
46
What is meant by the momentum effect?
Increases willingness to invest in companies that show prospects for growth
47
What is an illusion of control?
An investor who believes their actions will directly affect the stock market and that they have a certain degree of control of the market
48
What is a confirmation bias?
Investors only seek information supporting their beliefs
49
What are preference shares a fixed percentage of?
The share's nominal value, there will be zero growth of the future cash flow
50
What should the market value of any debt equal?
The present value of the future payments to the investor discounted at the required return
51
What should the market value of a redeemable loan note equal?
The PV of the coupon interest (paid each year until maturity) and the redemption price (paid at maturity), discounted at the investors' required rate of return
52
What are convertible loan notes/
allow the investor to choose between redeeming the loan notes at some future date or converting them into a predetermined number of ordinary shares.
53
Floor value in convertible loan notes
Floor value
54
Conversion premium in convertible loan notes?
Market value - current conversion value
55
What does the market value of a loan note equal to?
The present value of the fixed future payments it will make to the investor.
56
What happens if the market interest rates fall?
The present value of a loan note’s future cash flows will rise, and with it, the loan note’s market price
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