Corporate Valuation Flashcards
Why do companies seek out projects with positive NPVs?
Because it implies that the rate of return on your investment is higher than your opportunity cost of capital (i.e. higher than you could earn by investing in financial markets).
How is the Dividend Discount Model (DDM) constructed?
The value of the stock equals the present value of the dividends plus the present value of expected sales revenue at the end of the holding period, both discounted at the rate of return that investors expect to receive on other securities with equivalent risks.
What is the Gordon Growth Model (GGM)
A special case of DDM for stocks with growing perpetuity, meaning that dividends are expected to grow forever at a constant rate of g.
Equity value= D(1) / (r-g)
g= ROE * plowback ratio
ROE: EPS / Book Value per Share
Plowback ratio: 1 - (Dividend / EPS)
What is the Present Value of Growth Opportunities (PVGO)?
The difference between value with and without growth.
How does the Payout Ratio influence the GGM?
Payout Ratio = Dividend / Earnings
- High payout ratio: high dividend yield today but limited growth implies lower dividend payments in the future
- Low payout ratio: low dividend yield today but strong growth implies higher dividend payments in the future
What are the (dis)advantages of the Discounted Cash Flow (DCF) Model?
Advantages:
Since it uses the free cash flows instread of dividends value (profits) of a company, the calculation is independent of dividend payments, profit considerations, and accounting policies, since these only affect profit and not cash flow
Disadvantages:
Transparency regarding the choosen amount of CAPEX
How do Multiple Valuations fit into the Corporate Valuation process and what are its (dis)advantages?
Multiple Valuations are applied as a additional valuation method in equity valuations and as a primary decision tool in investment decisions.
To use them, one determines a peer group and chooses the financial ratios one wishes to apply.
Advantage: few assumptions, easy to calculate and compare
Disadvantage: lack of transparency, neglects risk, limited forward looking
