Q1

Question 1

Sensitivity Analysis - Strengths (3)

Answer 1

1. Presented in a way that facilitates subjective judgement
2. Identifies critical areas that need to be monitored
3. No complicated theory / relatively straightforward

Question 2

Sensitivity Analysis - Weaknesses (3)

Answer 2

1. Only one factor can be analysed at a time (and presumes these can be changed independently)
2. Only identifies how far a variable needs to change (doesn’t consider probability)
3. Info provides basis for decisions, not correct decision

Question 3

Simulation - Strengths (2)

Answer 3

1. Provides information about possible outcomes as well as their relative probabilities.
2. Useful for problems which cannot be solved analytically.

Question 4

Simulation - Weaknesses (3)

Answer 4

1. Not a technique for making a decision, only for obtaining info about possible outcomes.
2. Can be expensive to design and run for complex projects.
3. Monte Carlo techniques require assumptions for probability distributions and relationships between variables.

Question 5

Real Options - Definition

Answer 5

• True worth of a project not always easy to identify
• May be unquantifiable, intangible issues that affect the investment
• Real options represent these intangible factors that may influence a decision

Question 6

Real Options - Different Types (5)

Answer 6

1. ‘Follow-on’: subsequent benefits might follow a project
2. ‘Abandonment’: even if the project fails, the result may not be too bad (e.g. compared to another project)
3. ‘Timing’: project allows for timing flexibility (e.g. development rights over land for 5 years)

Question 7

Shareholder Value Analysis - Value Drivers (7)

Answer 7

S - Sales growth rate
L - Life of projected cash flows
O - Operating profit margin
W - Investment in working capital
C - Cost of capital
A - Investment in non-current assets
T - Corporation tax rate

Question 8

Asset-Based Valuation - Strengths (3)

Answer 8

1. Simple to calculate
2. Assets are more certain than income
3. Useful for ‘asset strippers’

Question 9

Asset-Based Valuation - Weaknesses (3)

Answer 9

1. Book values are likely to be out of date
2. Ignores future earnings
3. Service businesses would be undervalued due to value of intangibles

Question 10

Income-Based Valuation - Strengths (2)

Answer 10

1. Technically the best method, especially for service businesses
2. Incorporates all available relevant cash flows and the time value of money

Question 11

Income-Based Valuation - Weaknesses (2)

Answer 11

1. Estimated cash flows may be too optimistic (especially the terminal value of a perpetuity)
2. Calculating a suitable discount rate can be problematic (especially for unlisted companies)

Question 12

PE Ratio Valuation - Strengths (2)

Answer 12

1. Reflects the stock market’s view of the potential of a company
2. Considers the earnings-creating potential of a company

Question 13

PE Ratio Valuation - Weaknesses (3)

Answer 13

1. Industry average / proxy company’s PE ratio may not reflect the company being valued
2. Earnings can be manipulated by accounting policies
3. Using past earnings may not reflect future potential

Question 14

Enterprise / EBITDA Multiple Valuation - Strengths (4)

Answer 14

1. Unaffected by capital structure / depreciation policies
2. Takes net debt into account
3. Enables direct comparisons between companies which might have different accounting policies
4. Technique most commonly used by investors

Question 15

Enterprise / EBITDA Multiple Valuation - Weaknesses (4)

Answer 15

1. Is simplistic; lot of info from many value drivers distilled into a single figure
2. Ignoring capex and tax can be a disadvantage (management can add value through tax know-how)
3. Using past earnings may not reflect future potential
4. Industry average / proxy multiple may not reflect company being valued

Question 16

Dividend Valuation - Strength (1)

Answer 16

1. Effective when investor is looking for dividend income rather than control

Question 17

Dividend Valuation - Weaknesses (2)

Answer 17

1. Dividend payments and growth may not be stable

2. Using the dividend yield / Ke of a proxy co. / industry average may not reflect co. being valued

Question 18

Shareholder Value Analysis - Strengths (2)

Answer 18

1. Based on the PV of future cash flows, so is forward-looking
2. Theoretically robust; doesn’t rely on earnings (which can be manipulated) or assets (which don’t show income generated)

Question 19

Shareholder Value Analysis - Weakness (1)

Answer 19

1. Predictions are very difficult as cash flows are technically in perpetuity

Question 20

Shareholder Value Analysis - Outline Technique (3)

Answer 20

1. Terminal value is calculated (based on cash flows to perpetuity) at a point where co’s competitive advantage has dwindled
2. Terminal value is major part of overall value of co.
3. Equity calculated by (i) adding short-term investments and (ii) deducting MV of debt held

Question 21

Types of Divestment (6)

Answer 21

D - Divestment
M - MBO
S - Spin-off
O - Outsourcing
L - Liquidation
D - Demerger