Lecture 5 - Valuation

Question 1

DCF Valuation

Answer 1

firm value = cash0 + (FCF1)/(1+WACC) + (FCF2)/(1+WACC)….

Question 2

cash included in DCF

Answer 2

EXCESS CASH

only include cash not needed for day-to-day operations; cash that is free to be paid out

Question 3

DCF valuation steps

Answer 3

1. find EXCESS cash today (cash0)
2. find PV of FCF estimates over non-constant growth period
3. find PV of horizon/TV of FCF in constant growth period

Question 4

non-constant growth period

Answer 4

diff growth rates during period

ends only when we can assume growth is stable

Question 5

constant growth period

Answer 5

value of firm in this period = TV

beginning in year N+1, we assume expected FCF will grow at constant rate g

Question 6

TVn

Answer 6

PV of all future FCFs in constant growth period discounted back to year N

Question 7

TVn =

Answer 7

(FCFn+1) / (WACC-g)

Question 8

firm value

Answer 8

PV of all future cash flows and today’s cash

Question 9

Equity value (MV) =

Answer 9

Firm value - debt

Question 10

what price should you be willing to pay at time 0 for stock? =

Answer 10

P0 = equity value / # of shares

Question 11

mid-year discounting

Answer 11

FCF discounted as mid year cash flows

Question 12

firm value w/ mid-year discounting =

Answer 12

cash0 + (1 + r)^1/2 * (PV FCF & TV)

Question 13

TV using book values =

Answer 13

= book value of assets

= LT assets + NWC

Question 14

TV using book values

Answer 14

a reasonable lower bound for a firm future value = future book value of assets

Question 15

why is TV using book values a lower bound?

Answer 15

bc we expect market values to rise above book values

Question 16

TV using multiples

Answer 16

find firm with similar business risk, growth prospects, and leverage

use its market multiple to predict TV of firm

Question 17

APV formula =

Answer 17

VL = Vu + PV (financial side effects)

Question 18

VL

Answer 18

value of project/firm accounting for how it’s financed

Question 19

Vu =

Answer 19

sum of PV of all FCF discounted by ra

Σ (FCFt) / (1 + rA)^t

Question 20

rA

Answer 20

unlevered return
return on assets
reflects only compensation for BUSINESS risk

Question 21

possible financial side effects

Answer 21

interest tax shields
cost of financial distress
agency costs of debt
direct cost of issuing equity/debt

Question 22

discount future tax shields by…

Answer 22

rD if firm is profitable
rA if firm is not profitable

appropriately accounts for riskiness

Question 23

interest tax shields =

Answer 23

rD * D * T
(calculate for every year)
how much expected cash flows the firm saves on taxes bc of interest expenses

Question 24

loans: principal @start of year =

Answer 24

(last year’s debt amount) * (1+rd) - equal payment

Question 25

advantage of using APV

Answer 25

works well with time-varying D/V | gives clear picture of exactly how financing affects project value

Question 26

tax shields are accounted for in WACC & APV by....

Answer 26

WACC - thru the discount rate | APV - thru financial side effects

Question 27

WACC & APV make following assumptions about D/E

Answer 27

WACC - assumes constant D/E | APV - gives simple way to account for changes in D/E

Question 28

EVA =

Answer 28

Cn - r*I Cn = CF in period n (ex. FCF) r = opp cost of capital (ex. WACC) assumes you are tying up capital I forever

Question 29

EVA investment rule

Answer 29

make investment if PV of all future EVA's discounted at cost of capital (r) is positive

Question 30

PV (EVA) =

Answer 30

Σ Cn / (1+r)^n - I = NPV

Question 31

5 steps to multiples

Answer 31

1. find comparable firms 2. choose many scaling bases (EBIT, sales) 3. calculate ave multiple for each scaling factor for comparable firms 4. come up with projection for scaling factor for your firm 5. use various multiples and projections to arrive at valuation

Question 32

EPS =

Answer 32

NI / Shares outstanding

Question 33

PE ratio =

Answer 33

Price per share / Earnings per share how much investors are willing to pay per dollar of current earnings

Question 34

higher PE ratio usually means....

Answer 34

firm has significant growth prospects / low expected returns

Question 35

constant dividend growth model =

Answer 35

P0 = (DPS1) / (rE-g)

Question 36

how does g impact PE ratio?

Answer 36

higher g = higher PE ratio

Question 37

how does rE impact PE ratio?

Answer 37

higher rE (expected return) = lower PE ratio

Question 38

how does payout ratio impact PE ratio?

Answer 38

higher payout ratio = higher PE ratio

Question 39

if PEf > PEm | fundamental PE > market PE

Answer 39

stock is undervalued | should BUY stock

Question 40

if PEf

Answer 40

SELL stock

Question 41

PEf =

Answer 41

[b * (1 + g)] / (rE - g)

Question 42

PEm =

Answer 42

P0 / EPS0