Lecture 4

Question 1

Which are the two reasons to value companies?

Answer 1

1. Deciding wether or not to invest in publicly traded companies
2. Determining the price when investing in a private firm, or when issuing new shares

Question 2

How do you calculate the market value of equity?

Answer 2

Number of shares outstanding * price per share

Question 3

What is an appropriate stock price according to the dividend-discount model?

Answer 3

The price should be equal to the present value of the expected future dividends

Question 4

State the benefits of using the dividend-discount model

Answer 4

• Very simple & intuitive

* If we observe the share price, we can back out other unobservable inputs from the formula

Question 5

State the problems with using the dividend-discount model

Answer 5

• Not very exact
• We have to assume that the riskiness of the firm stays constant
• Uncertainty associated with forecasting a firm’s dividend growth rate and future dividends
• Small changes in the assumed dividend growth rate can lead to large changes in the estimated stock price

Question 6

How can you use the dividend-discount model to calculate cost of equity?

Answer 6

Substitute share price with discount rate (i.e. cost of equity)

Question 7

How can dividend payments be increased?

Answer 7

Increase earnings, decrease # shares outstanding, or increase dividend payout rate

Question 8

When can lowering the dividend payout rate actually increase the share price?

Answer 8

When the market expects that the rate is decreased to save capital for a large, profitable investment

Question 9

How can the dividend-discount model be used for firms that do not show constant growth, e.g. young firms?

Answer 9

1. Forecast individual dividends in the first few years (they can take any numbers you deem reasonable)…
2. … then use a constant growth model for the “stable” part of a firm’s life

Question 10

State the formula for enterprise value

Answer 10

Enterprise Value = Market Value of Equity + Debt − Cash

Question 11

How can you obtain the EV (enterprise value)?

Answer 11

Discount the free cash-flows:

EBIT × (1 − τ) + Depreciation − Capital Expenditures − Increases in Net Working Capital

Question 12

Which measure is used as discount rate when using the discounted free cash flow model?

Answer 12

The WACC, since free cash flows include both debt and equity

Question 13

State the formula for market value of equity

Answer 13

Market Value of Equity = Enterprise Value – Debt + Cash

Question 14

What is a valuation multiple?

Answer 14

A ratio of firm’s value to some measure of the

firm’s scale or cash flow

Question 15

Which are the basic steps of the “multiples valuation” method?

Answer 15

1. Take an accounting number from the company we want to value (e.g., earnings)
2. Get the multiples (e.g., Price/Earnings) of 5-10 closely comparable companies
3. Calculate the average or median
4. Multiply the earnings figure from the company we want to value with the average P/E estimate from the comparable firms
5. Viola: that’s our estimated share price

Question 16

Give examples of some valuation multiples

Answer 16

– Price/Earnings
– Multiple of sales
– Price to book value of equity per share
– Enterprise value per subscriber
– Enterprise value per hits

Question 17

Name two limitations of multiples valuation

Answer 17

1. Very dependent on being able to find comparable forms

2. Using multiples will not help us determine if an entire industry is overvalued