Lecture 1-2 Intro to Valuation

Question 1

The three approaches of valuation

Answer 1

Income approach - Discounting the future cash flows of the firm to the present . It focuses on risk factors and a long-term view of the company. However, requires a lot of information

Market approach - Valuing a company based on market multiples. Easy and gives us perception of the market’s perception. However, this is very susceptible to cyclicality and manipulation of valuables. It assumes there are stock prices of comparable assets

Cost approach- Value of all individual items on the balance sheet. Each item is valued at current conditions

Question 2

Income approach?

Answer 2

Discounting the future cash flows of the firm to the present . It focuses on risk factors and a long-term view of the company. However, requires a lot of information
FCFO
FCFE
DCF (APV is part of it)

Question 3

Market approach?

Answer 3

Valuing a company based on market multiples. Easy and gives us perception of the market’s perception. However, this is very susceptible to cyclicality and manipulation of valuables. It assumes there are stock prices of comparable assets

Trading Multiples and Deal Multiples

Question 4

What are the three main inputs. which the DCF model requires?

Answer 4

Cash Flows
Discount Rate
Time Horizon

Question 5

What are the steps needed to build a DCF model?

Answer 5

1. Estimate the current earnings and cash flow to debt holders (FCFO)
   Estimate the current earnings and cash flow to equity holders (FCFE)
2. Estimate the discount rates:
   Cost of equity - Equity holders
   WACC - Debt/claim holders
   Real interest rate
3. Estimate the forecast earnings and cash flows (with a full business plan or more synthetic growth rates in earnings)
4. Estimate when the firm will reach stable growth and what characteristics it will have then.

5.Choose the correct DCF mode (equity/asset side/APV)

Question 6

Pros and cons of the DCF model?

Answer 6

Pros:
Not affected by the market moods and perceptions, it values fundamentals!
Forces to think about the underlying characteristics of the firm and the business

Cons:
Requires lots of data
Inputs/data can be manipulated to provide a conclusion they want
A lot of the info is difficult to estimate

Question 7

Which parts of the buisness does the DCF model value and how?

Answer 7

It values the sum of the different businesses of a company.
It values the growth opportunities of a firm separately from the core business of the company.
Surplus assets are valued separately from the sum of the different businesses!

Question 8

What is relative valuation?
What it is based on?
What are the inputs?

Answer 8

It values an asset or a company by looking at the prices of similar companies and assets and estimating it.

It is based on the efficient market hypothesis.

Question 8

What is relative valuation?
What it is based on?
What are the inputs?
What are the two methods?

Answer 8

It values an asset or a company by looking at the prices of similar companies and assets and estimating it.

It is based on the efficient market hypothesis.

• Group of comparable/similar companies
  -Standardized measure of value. This means to divide the price by a similar variable (P/E,P/B,etc.)
• If not perfectly comparable there need to be variables to offset the differences

Market multiples and Deal Multiples

Question 9

Relative Valuation Pros and Cons?

Answer 9

Pros:
Easy to estimate
Reflects market sentiment (Can be advantageous when the objective is to sell a security at that price today - IPO)
Requires less information

Cons:
Tendency to pro-cyclicality
Multiples are easy to manipulate
No two firms are exactly the same

Question 10

The value of a business is the sum of?

Answer 10

The book value of its invested capital as of today + the future cash flows (excess returns) (can be negative)

Question 11

What are asset based valuation methods?

Answer 11

They determine the value from a careful estimate of the value of each asset (tangible and intangible) + the liability that represents the invested capital in the firm.

Can match DCF if the company is not growing and the market assessment of value reflects the expected cash flows

Used for valuing real estate assets and holding companies

Question 12

What is the process to deal with risk?

Answer 12

1. Assess the business model
2. Assess the competition and the market
3. Analyze risk factors
4. Build scenarios
5. Develop cash flow model

Question 13

What does the choice of valuation standpoint depend on regarding uncertainty?

Answer 13

It depends on the level of uncertainty and managerial flexibility