Chapter 20 - Business valuations and market efficiency Flashcards
(49 cards)
Valuations of share in both public and private companies are needed for several purposes including what?
- to establish terms of takeovers and mergers
- to be able to make ‘buy and hold’ decisions
- to value companies entering the stock market
- establish values of shares held by retiring directors, which the articles of the company specify must be sold
- for fiscal purposes (CGT, Inheritance tax)
- divorce settlements
How do we calculate the market capitalisation of public companies?
current share price x no. of shares in issue
The real worth of a company will be known when?
once a purchase has been made after negotiation between the two parties
The accounting equation states what?
Total assets = shareholders’ equity + liabilities
Therefore follows that:
Shareholders’ equity = total assets - liabilities
What are the 3 alternative asset valuation bases?
- Book value
- Replacement
- Breakup value/ NRV
What is the book value bases?
- value is largely a function of depreciation policy
What is the replacement value bases?
Useful for the buyer. If the buyer wants to estimate the minimum price that would have to be paid to buy the assets and set up a similar business from scratch
What is the breakup value/NRV?
Useful for the seller. Considers the amount they would receive if they were to liquidate the business as an alternative to selling the shares.
Useful for a buyer if their intention is to strip the assets and sell them
What are some problems of asset-based valuations?
- asset based valuations do not value what is being purchased, i.e., the right to future earnings/cash flows of the company
- asset based valuations ignore intangible assets, such as goodwill
What are advantages with asset-based valuations?
- the valuations are fairly readily available
- they provide a minimum value of the entity
When are income/earnings based valuation methods particularly useful?
when valuing a majority shareholding
What do income/earnings based valuation methods reflect?
that the investor has additional benefits of control, which means they have access to the earnings of the business, not just the dividends (as they can influence dividend policy)
What is the PE ratio calculation?
Value per share = EPS x P/E ratio
Total value of equity = Total earnings x P/E ratio
What are some disadvantages of the PE ratio valuation method?
- they are based on accounting profits rather than cash flows
- it is difficult to establish the relevant level of sustainable earnings
What are some advantages of the PE ratio valuation method?
- They are commonly used and are well understood
- they are relevant for valuing a controlling interest in an entity
What is the earnings yield method?
inverse of the PE ratio
What is the calculation for the earnings yield method?
value per share = EPS / earnings yield
total value of equity = total earnings / earnings yield
When incorporating constant growth in earnings what is the calculation?
Total value of equity = (earnings x (1-g)) / (earnings yield -g)
What is the dividend valuation model used for?
used for valuing a minority shareholding in a company
If dividends are growing what calculation will be used?
Po = Do (1+g) / (re -g)
If dividends are constant what calculation will be used?
Po = D / re
What are some strengths and weaknesses of the DVM?
- problems estimating a suture growth rate
- growth assumed to be zero or at a constant rate
- high sensitivity to changes in the assumptions used
- few advantages over earnings based methods for controlling interests
What is the growth caluclation?
g = (Do / Dn) ^(1/n) - 1
The value of equity is derived by what?
estimating the future annual free cash flows of the entity, and discounting these cash flows at an appropriate cost of capital
