Chapter 13

Question 1

What is the process for valuing equities?

Answer 1

Goal - find stocks worthy of investing in
General process:
General economic conditions & monetary and fiscal policies
Industry influences
Company analysis

Question 2

Is discounted cash flow model good?

Answer 2

Theoretically correct but sensitive to:
1. growth rate
2. estimate of discount rate

Question 3

Is relative valuation good?

Answer 3

Does not predict future
Useful when:
1. good comparables
2. market and industry are not an extreme

Question 4

What is intrinsic valye?

Answer 4

PV of cash payments

Question 5

What is the market price?

Answer 5

Consensus value of all potential trades

Question 6

What is the dividend discount model?

Answer 6

V0 = sum(Dt/(1+k)^t)

Question 7

What is the no growth model?

Answer 7

V0 = D/K

Question 8

What is the constant growth formula?

Answer 8

V0 = (D0(1+g)/k-g)
g = constant perpetual growth rate

Question 9

How do you calculate growth?

Answer 9

g = ROE x Earnings Retention Rate (ERR)

Question 10

What happens when all earnings are paid out?

Answer 10

P will be lower
- assuming growth opportunities exist - if they do not then Board makes decision on appropriate capital allocation

Question 11

What is a company’s life cycle?

Answer 11

If there if high growth - low dividend
If there is low growth (mature company) - high dividend

Question 12

How do you calculate OFCF?

Answer 12

EBIT(1-tc) + depreciations - capital expenditures - increase in NWC (net working capital)
tc = corporate tax rate