L13 - Equity Valuations

Question 1

What are the different valuation concepts?

Answer 1

• Book value
  
  • – Historical values (costs of acquisition of assets)
• Market price
  
  • – Current value of assets and liabilities
• Fundamental value (or, intrinsic value)
• Liquidation value: lower bound on market value (otherwise takeover target)
• Replacement cost: if the market price is far above replacement cost, competitors are likely to move into this business
  
  • Easy to create a similar firm at the replacement cost which is similar to the market price

Question 2

How can you calculate the fundamental value?

Answer 2

Question 3

What is the Dividend Discount Model?

Answer 3

• to find out the fundamental value of a firm we just value it as the sum of all its dividend discounted to their PV

Question 4

What did Warren Buffet say about Intrinsic Value?

Answer 4

• “Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.”
• Example: Book value / intrinsic value of a college education
  
  • – Upon graduation, the book value of education is what you paid for it (plus lost income). The intrinsic value is the present value of future earnings in excess of what would be earned without the education. (Also, there is the pleasure connected with knowledge.)

Question 5

What is the Gordon’s Growth Model?

Answer 5

• Simplification of the Dividend Growth Model
  
  • This only works if E(r) > g
  • Values further in the future as smaller and tend towards zero –> means we will converge on one number
• Can get this equation by using the following:
  
  • Geometric series is a + ar +ar²…
  • Sum to infinity of this series is a * 1/1-r
  • In the equation r = (1+g)/(1+E(R)) and a = D₀*r
    
    • a is multiplied by r as we start discounting from period 1 whereas in the geometric series we start at ar^0 = 1 so by dividing through by r we can get the infinite series sum
  • Sub in the sum to infinity equation for this answer
    
    • V = D*r/(1-r) –> sub in for r

Question 6

What valuation ratios and relative valuations can be derived from the Gordons growth model?

Answer 6

• Price to dividend ratio
• Price to earnings ratio
  
  • P/D ratio * (1-b)
• Price to book ratio

Question 7

What is the two-stage dividend discount model (DDM)?

Answer 7

Question 8

Example of the two-stage DDM model?

Answer 8

assume at some point in the future dividends are gonna grow at a constant rate thus we have to find out the price in that year and discount it to its PV