valuations Flashcards
(20 cards)
Why are valuations done?
For buying/selling shares, tax purposes (e.g., estate duty), using shares as security, and financial reporting
What is the fundamental principle of all valuations
Present value of all future expected cash flows discounted at the required rate of return.
What are the building blocks of valuation?
Amount of each future cash flow
Timing of cash flows
Riskiness of cash flows
Required rate of return (Ri)
What is a perpetuity?
An asset with infinite life and no redemption date. It pays a constant stream of cash flows
How do you calculate the value of a perpetuity?
Value= PMT/ Ri
(PMT = Cash flow per year, Ri = required rate of return)
What is the CAPM formula?
Ri = Rf+β (Rm−Rf )
What happens to value when the required return increases?
Value decreases because cash flows are discounted more heavily
What are debentures?
Loan instruments not normally secured by assets, issued in denominations to raise funds
How do you value a non-redeemable debenture?
value = coupon/ Ri
it’s a perpetuity
How do you value a redeemable debenture?
Use time value of money formula with:
FV = redemption value
PMT = coupon payments
I/YR = required return
N = number of periods
What are government bonds?
Debt instruments issued by the government, considered risk-free and used to benchmark returns
What is yield to maturity (YTM)?
The return earned by holding a bond until it matures, considering all coupon payments and the purchase price
What are preference shares?
Shares with fixed dividends, paid before ordinary dividends, often cumulative and non-voting
What’s the value of cumulative, non-redeemable preference shares?
value = dividend/ Ri
What’s the difference between cumulative and non-cumulative preference shares?
Cumulative: Missed dividends are accumulated and paid later.
Non-cumulative: Missed dividends are lost.
What if dividends are deferred for 2 years (cumulative)?
Calculate present value of deferred lump-sum dividends + present value of perpetuity starting from year 3.
When will a company choose to redeem preference shares?
If current div. rate > future market rate → company redeems
If current div. rate < market rate → company does NOT redeem
How do you value ordinary shares?
Use a simplified dividend discount model, considering:
value = profits available/ Ri
What is the difference between cum dividend and ex dividend?
Cum dividend: Buyer receives upcoming dividend
Ex dividend: Buyer does not receive the declared dividend
What is a basis point?
1 basis point = 0.01%
100 basis points = 1%
