Chapter 6: Business Valuations Flashcards
(19 cards)
Asset based valuations
Use of historic cost,
replacement cost or
realisable value?
market capitalisation
share price × no of shares
Adv and disadv of Asset based valuations
Advantages
-Quick and simple to estimate.
-Gives a starting point/benchmark.
Disadvantages
-Not as good at valuing the on-going earnings/profit
potential of the business.
-Does not consider valuation of assets not shown on
the statement of financial position such as intangible
assets.
Income based valuations - P/E valuation
How do you calc market value of all ordinary shares?
How do you calc market value of an individual ordinary shares?
P/E = Share Price / EPS
MV of ordinary shares = P/E ratio * current earnings (PAT usually)
Share Price = P/E Ratio * EPS
Income based valuations - P/E Valuation Advantages and disadvantages
Advantages
-Quick to calculate
-Considers future potential.
-Useful for valuing unquoted companies.
Disadvantages
-Adjustments may be necessary to both the P/E and earnings figure
-Which P/E to use in a takeover situation (target co’s, predator co’s or an average)?
Income based valuations - Earnings yield
How do you calc market value of all ordinary shares?
How do you calc market value of an individual ordinary shares?
The Earnings Yield ratio is calculated as Earnings/MV of shares or EPS/Share Price (inverse of the P/E ratio).
Market value of all shares - Earnings (PAT) / Earnings yield
Share price - EPS/Earnings yield
Cash flow based valuations - discounted
If you want to find the MV of the shares in a business you should take the CASHFLOWS attributable to the shareholders (after interest and tax) and discount using a shareholders required return (the cost of equity, Ke).
If cash flows (before interest but after tax) are discounted at the WACC the result will give the total value (debt + equity) of the business, so to get the value of the shares only you need to deduct the market value of any debt.
Cashflows: Cashflow after interest and tax
Discount rate to use: Cost of equity
Result: MV of equity
Cashflows: Cashflow before interest, but after tax
Discount rate to use: WACC
Result: MV of equity + MV of debt
Cash flow based valuations - discounted
Advantages and disadvantages
Advantages
-Considers future potential.
-Can be used to value any business
Disadvantages
-Future cash flows will be estimates only.
-Requires a cost of capital to be estimated
-Determining the time horizon for future cashflows is problematic. If constant growth is assumed after a point, then a large part of the valuation will be based on a very simplified estimate.
Cash flow based valuations - Dividend yield
How do you calc market value of all ordinary shares?
How do you calc market value of an individual ordinary shares?
Dividend yield = DPS/Share Price
MV of all shares = Dividends/Dividend yield
Share Price = DPS/Dividend yield
Dividend yields are only available for quoted companies, so if valuing a non-listed company you will have to use the dividend yield of a similar listed company and make some adjustments to your valuation
Cash flow based valuations - Dividend growth model
Formula given in exam
Po = Do(1+g)/(re-g)
Po = Current ex-div share price
Do = Current dividend
re = Return on equity or the cost of equity
g = Constant growth in dividends
Cash flow based valuations - Dividend growth model
Advantages and disadvantages
Advantages
-Considers future cash flows to shareholder
-Relevant for minority interests.
Disadvantages
-Assumes dividends grow at a constant rate forever
-Requires a cost of equity to be estimated
-Spurious results arise for businesses that don’t pay
dividends (zero value) or where growth (g) > cost of
equity (ke) (negative value).
The valuation of debt and other financial assets
Irredeemable debt
Po = I/rd
Po = Current ex-interest debt value
I = Interest
rd = Required return of the debt holders
The valuation of debt and other financial assets
Redeemable debt
Using NPV
The valuation of debt and other financial assets
Convertible debt
Using NPV
The valuation of debt and other financial assets
Convertible debt
What is the floor value?
Rather than calculating the market value, we could calculate the floor value which assumes that the debt will not be converted but redeemed.
PV of redemption
The valuation of debt and other financial assets
Convertible debt
What is the conversion premium?
The conversion premium is the difference between the current market value of the convertible debt and the current conversion value of the shares.
This is the extra value in holding the convertible debt rather than the equivalent shares.
It is the difference between the npv’s of if the shares got converted and if they didnt
The valuation of debt and other financial assets
Preference shares
Po = Do/Kp
Market efficiencies
Weak
Semi-strong
strong
Weak form - reflects all information available from past changes in the price. All past information which has now become a fact. The market cannot be beaten by technical analysis.
Semi-strong - Share prices reflect all information available from past changes in the price and any publicly available current information. Market cannot be beaten by reading the news or published accounts.
Strong - Above and any insider information. Hence the market cannot be beaten
Dividend valuation model
have next years dividend already
D1/(ke-g)
