Week 5

Question 1

What are perpetuity?

Answer 1

When a constant cash flow will occur at regular intervals forever it is called a
perpetuity

Question 2

What is the equation for present value of a perpetuity?

Answer 2

PV(C in perpetuity) = C/r

Question 3

What is the equation for present value of a growing perpetuity?

Answer 3

PV (growing perpetuity) = C/(r-g)

Question 4

Equation for Present Value of an Annuity?

Answer 4

PV = C x (1/r) x (1-1/(1+r)^n)

Question 5

Equation for Present Value of a Growing Annuity?

Answer 5

PV = (C x 1/(r-g)) x (1-((1+g)/(1+r))^n)

Question 6

What are valuation of stock?

Answer 6

-Prices are primarily based on underlying economic information and gradually reflect that information

Question 7

What is an investors expectation of the stock price?

Answer 7

• an investor forms an expectation of the stock price based on the cash flows he will receive and the appropriate cost of capital, which is used
  to discount these

Question 8

Equation for total return?

Answer 8

Total return = Dividend Yield + Capital Gain

Question 9

Limitations of the Dividend-Discount model?

Answer 9

-Dividends are uncertain (payout and level)
- Small changes in dividend growth rate can have substantial impact
on the estimated share price
- Often the dividend growth rate changes in complex patterns
throughout the firm’s cycles

Question 10

What is a valuation multiple?

Answer 10

Valuation Multiple is a ratio of firm’s value to some measure of the firm’s scale or cash
flow

Question 11

What is the Discount-Dividend Model

Answer 11

The Discount-Dividend Model (DDM) is a method used to value a company’s stock by determining the present value of its expected future dividends. This model assumes that the value of a stock is the sum of all future dividends that an investor will receive, discounted back to the present using a required rate of return.

Question 12

equation for Discount-Dividend Model

Answer 12

P↓0 = is the current price of the stock.
Div↓1 = dividend
r↓E = cost of equity or expected return
g = dividend growth rate

P↓0 = Div↓1/(r↓E - g)
r↓E = (Div↓1/P↓0) + g

Question 13

What should you remember Applying the Discount-Dividend Model?

Answer 13

The value of the firm depends on the current dividend level, the cost of equity, and the growth
rate.

Question 14

What is P/E ratio?

Answer 14

The Price-to-Earnings (P/E) ratio is a financial metric used to evaluate the valuation of a company’s stock. It measures the price investors are willing to pay for each dollar of earnings generated by the company. The P/E ratio is one of the most commonly used indicators to assess if a stock is overvalued or undervalued.

Question 15

equation for P/E ratio

Answer 15

Stocks price / earnings per share (EPS)

Question 16

What are Limitations of Multiples

Answer 16

• Conditions for the multiples working. In an ideal world, their multiples would match precisely if firms were identical.
• Real world practice. In reality, firms are not identical. So the usefulness of multiples will depend on the nature
  of differences between firms and the sensitivity of multiples to these differences.
• The differences in these multiples are mostly likely due to differences in expected future
  growth rates, profitability, risk, or differences in accounting policies.
• However, there is no clear guidance about how to adjust for differences.
• A key shortcoming of the comparable approach is that it does not take into account the
  important differences among firms.