Equity Valuation

Question 1

FCFF from EBITDA

Answer 1

EBITDA x (1-T) + Dep x (T) - WCInv - FCInv

Question 2

FCFF from EBIT

Answer 2

EBIT x (1-T) + Dep - WCInv - FCInv

Question 3

FCFF from NI

Answer 3

NI + NCC + Int x (1-T) - WCInv - FCInv

Question 4

FCFF from CFO

Answer 4

CFO + Int x (1-T) - FCInv

Question 5

FCFF to FCFE

Answer 5

FCFF - Int x (1-T) + Net Borrowing

Question 6

Constant growth residual income

Answer 6

BV0 +[(ROE-r)/(r-g)] x BV0

Question 7

Clean surplus

Answer 7

Ending book value of equity equals the beginning book value plus earnings minus dividends, apart from ownership transactions.

Question 8

Discounts on private investments

Answer 8

Total Discount = 1 − [(1 − DLOC)(1 − DLOM)]

Question 9

PRAT model

Answer 9

G = P x R x A x T

Question 10

Total Discount Private Companies

Answer 10

Total Discount = [1 – (1 – DLOC)×(1 – DLOM)]

Question 11

Private company discount steps

Answer 11

First move from controlling to non-controlling basis
Second move from marketable to non-marketable basis

Question 12

Define Intrinsic Value and sources of mispricing.

Answer 12

Intrinsic value (V) is the true, underlying value based on fundamentals. Perceived mispricing arises from the difference between Market Price (P) and Estimated Value (VE​). Actual Mispricing = V - P. Valuation Error = VE​ - V.

Question 13

Contrast Going Concern Value and Liquidation Value.

Answer 13

Going Concern: Assumes the company continues operating indefinitely; value based on future cash flows. Liquidation Value: Assumes assets sold off; value is net proceeds after paying liabilities. Most relevant for public companies is typically Going Concern or Intrinsic Value.

Question 14

Contrast Absolute and Relative Valuation models.

Answer 14

Absolute: Value derived from fundamentals/cash flows, independent of market prices (e.g., DDM, DCF (FCFF/FCFE), Residual Income). Relative: Value estimated by comparing price multiples or ratios to comparable companies or benchmarks (e.g., P/E, P/B, P/S, EV/EBITDA).

Question 15

What is Sum-of-the-Parts valuation?

Answer 15

Valuing different divisions/segments of a company separately (using appropriate methods for each) and summing them up. Often used for conglomerates, which may trade at a discount to this value.

Question 16

When are Dividends, FCFE, and Residual Income most suitable for DCF valuation?

Answer 16

Dividends: Mature companies with stable dividend history, minority shareholders perspective. FCFE: Companies that pay dividends differing significantly from FCFE capacity, controlling shareholder perspective. Residual Income: Companies not paying dividends, negative FCFE, transparent accounting.

Question 17

What is the Gordon Growth Model (GGM) formula and its assumptions?

Answer 17

V0​=D1​/(r−g). Assumes: constant perpetual dividend growth (g), g < r, stable business risk influencing r.

Question 18

What is the Present Value of Growth Opportunities (PVGO)?

Answer 18

PVGO=V0​−(E1​/r). Represents the portion of the stock’s value attributable to expected future growth beyond the no-growth earnings level. Leading P/E = (1/r) + (PVGO / E1).

Question 19

Define Justified P/E ratios (Leading and Trailing) based on GGM.

Answer 19

Justified Leading P/E: P0​/E1​=(D1​/E1​)/(r−g)=(1−b)/(r−g). Justified Trailing P/E: P0​/E0​=[(1−b)(1+g)]/(r−g). Where ‘b’ is the retention ratio.

Question 20

Contrast the stages in multi-stage DDM/FCF models (Growth, Transition, Maturity).

Answer 20

Growth: Rapidly expanding markets, high profit margins, high growth rate > r. Transition: Growth slowing due to competition, margins declining, growth rate approaches r. Maturity: Growth stabilizes at a sustainable long-term rate (often <= economy growth rate), g < r.

Question 21

What is the H-Model formula and its assumption?

Answer 21

V0​=[D0​(1+gL​)+D0​H(gS​−gL​)]/(r−gL​). Assumes linear decline in growth rate from short-term (gS​) to long-term (gL​) over 2H periods. H = half-life of high growth period.

Question 22

How is Sustainable Growth Rate (SGR) calculated and linked to DuPont?

Answer 22

SGR=b×ROE, where b = retention ratio = (1 - Dividend Payout Ratio). DuPont decomposes ROE: ROE=(NI/Sales)×(Sales/Assets)×(Assets/Equity) (Net Profit Margin x Asset Turnover x Financial Leverage).

Question 23

Define FCFF and FCFE.

Answer 23

FCFF (Free Cash Flow to Firm): Cash flow available to all capital providers (debt & equity) before financing payments. FCFE (Free Cash Flow to Equity): Cash flow available to common shareholders after debt payments (interest & principal).

Question 24

How are FCFF and FCFE calculated starting from Net Income?

Answer 24

FCFF: NI+NCC+Int(1−T)−FCInv−WCInv. FCFE: NI+NCC−FCInv+NetBorrowing−WCInv. (NCC=Non-cash charges, FCInv=Fixed Capital Inv, WCInv=Working Capital Inv).

Question 25

How are FCFF and FCFE calculated starting from CFO?

Answer 25

FCFF: CFO+Int(1−T)−FCInv. FCFE: CFO−FCInv+NetBorrowing.

Question 26

How do dividends, repurchases, share issues, and leverage changes affect FCFE vs. Dividends?

Answer 26

Dividends & Repurchases are uses of FCFE. Share issues & Net Borrowing (debt issue - debt repayment) are sources affecting FCFE calculation, but not FCFF. Dividends are discretionary, FCFE reflects capacity.

Question 27

Define Underlying Earnings and methods for Normalizing EPS.

Answer 27

Underlying (Persistent/Core) Earnings exclude non-recurring items. Normalization Methods: 1) Average historical EPS over a cycle. 2) Average historical ROE x Current BVPS. Goal is to estimate mid-cycle or sustainable earnings power.

Question 28

What is the P/E-to-Growth (PEG) ratio?

Answer 28

PEG=(P/E)/g. Lower PEG suggests more attractive valuation relative to growth. Limitations: assumes linear P/E-g relationship, ignores risk, uses forecast g.

Question 29

Define common Enterprise Value (EV) multiples.

Answer 29

EV/EBITDA: Most common; EBITDA is pre-tax, pre-interest, pre-depreciation proxy for operating cash flow. EV/Sales: Useful for negative earnings firms. EV/Invested Capital. EV = Market Cap + Market Value Debt + Preferred Stock + Minority Interest - Cash & Equivalents.

Question 30

Define Residual Income (RI).

Answer 30

RIt​=NetIncomet​−EquityCharget​=Et​−(re​×Bt−1​). Economic profit exceeding the required return on equity capital.

Question 31

How is intrinsic value calculated using the Residual Income model?

Answer 31

V0​=B0​+∑t=1∞​(1+re​)tRIt​​=B0​+∑t=1T​(1+re​)tRIt​​+(1+re​)TPVTerminalRI​​. Current book value plus PV of expected future residual income.

Question 32

What is the relationship between RI valuation and Justified P/B?

Answer 32

P0​/B0​=1+B0​PV(Future RI)​. If RI>0, justified P/B>1. Based on constant growth RI: P0​/B0​=1+re​−gROE−re​​=re​−gROE−g​.

Question 33

Define Economic Value Added (EVA) and Market Value Added (MVA).

Answer 33

EVA=NOPAT−(WACC×TotalCapital)=EBIT(1−T)−(WACC×Capital). Measures economic profit using WACC. MVA=Market Value−Total Capital. Difference between market value and capital invested.

Question 34

FC_inv

Answer 34

change in carrying value + dep expense – gain on disposal

Question 35

Weighted harmonic mean

Answer 35

1/sum([1/value x weight])

Question 36

Private company, company specifics

Answer 36

Stage in life-cycle Size Overlap of shareholders and management Quality and depth of management Quality of financial and other information Less pressure from short-term investors Tax considerations

Question 37

Residual Income Finite horizon

Answer 37

Overdefined period B0 + PV(RI_forecast period) + (PT - BT)/(1+r)^T Where the final term is the premium over book value

Question 38

Residual income with fade

Answer 38

Denominator of final residual income (1+𝑟−𝜔)(1+𝑟)𝑇−1 Persistance factor between 1 and 0

Question 39

Adjustments to private company income statements

Answer 39

Try to move revenue/expenses to fair market if they involve related party transactions and produce an ongoing distortion. Distortions related to excessive compensation or discretionary expenses Often separate real estate from operating company and deduct market rent from earnings

Question 40

DLOC

Answer 40

1-[1/(1+Control Premium)]

Question 41

Levered beta

Answer 41

beta_unlevered * [1+(1-t) * (Debt/Equity)]

Question 42

Value of firm

Answer 42

Value of operating assets + value of non-operating