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CFA II Equity
Terms in this set (24)
Incorporating Emerging market risk into valuation
Need to adjust cash flows in a scenario analysis b/c 1. country risk is diversifiable and one-sided; 2. company react differently to country risk; 3. identifying cash flow effects aids in risk mgmt.
How Inflation affects estimation of cash flow in Emerging markets
1. Income taxes are paid in nominal earnings, not real earnings; 2. Real cash outflow from NWC =/ the change in real NWC so calculate nominal NWC 1st and convert them to real cash flows using the inflation index; 3.Nominal CapEx is difficult to forcest since the relationship b/t nominal Sales and nominal CapEx IS NOT constant when high inflation, therefore CapEx, DEP and EBITDA should be focused on real basis.
Free Cash Flow
FCF = NOPLAT +DEP -FCInv-WCInv
Justified P/E Multiple
1. Trailing: (1-b)(1+g)/(r-g); 2. Leading: (1-b)/(r-g); b: retention ratio * trailing multiple will be larger then justified leading p/e multiple by (1+g)
Justified P/B Multiple
(ROE-g)/(r-g) conclusion: P/B increases as ROE increases; The larger the spread b/t ROE and r, the higher P/B multiple.
Justified P/S Multiple
net profit margin
(1+g) ] / (r-g) ] --> conclusion: progit margin increases or earning growth increases will cause P/S multiple to increase.
Justified P/CF Multiple
1. calculate the value of stock using DCF model; 2. dividing the result by CF; For Example: V₀ = FCFE₀ * (1+g)/(r-g); then P/CF = V₀/FCFE₀ --->conclusion: require return decreases or earning growth increases will cause P/S multiple to increase.
Justified Dividend Yield
D₀/P₀ = (r-g)/(1+g)
Method of Comparables Compares firm P/E to benchmark P/E Using the Following Steps
1. Select and Calculate the firm multiple; 2. Select the benchmark and calculate the mean/medium of PE over group of comparable stocks; 3. Compare firm PE to benchmark PE; 4. Exam the difference and make appropriate valuation adjustments;
Drawbacks of PEG Ratio
1. relationship b/t PE and g is not linear; 2. PEG does not account for risk; 3. PEG does not reflect the duration of the high-growth period;
Alternative Definitions of CF
1. CF = NI + DEP +AMORT; 2. adjusted CFO = CFO + INT * (1-t); (it ignores WCInv and NonCashRevenue; 3. FCFE = CFO -FCInv + NET BORROWING;(prefered but more volatile) 4. EBITDA (better as indicator of firm value)
EV = MV OF COMMON + MV OF PREFERED + MV of DEBT + MINORITY INTEREST - CASH - INVESTMENTS; When used: 1. more useful then PE when comparing firm with diff. degree of financial leverage; useful for valuing capital intensive busineses with high level of DEP and AMORT; 3 usually positive when EPS is not. Drawbacks: if WC is growing, then EBITDA will overstate CFO; 2. FCFF captures FCInv, it more linked with valuation theory, EBITDA would be OK if CAPEX = DEP;
as known as Dollar-Cost Averaging; Portfolio or Index PE is best calculated as the weighted Harmonic mean PE; When there are extreme outliers, the arithmetic mean will be the most affected; Harmonic mean put more weight on smaller values; For equal weighted, the harmonic mean and weighted harmonic mean will be same.
Economic Value Added (EVA)
Measures the value added for shareholders by mgmt during a given YEAR. EVA = NOPAT - (WACC X Invested Capital) = EBIT (1-T) -$WACC; $WACC: dollar cost of capital; Invested Capital: NetWC + NetFixedAssets = BV of LT Debt + BV of EQUITY
Market Value Added (MVA)
difference b/t the MV of LT Debt and Equity and the BV of Invested Capital; measures the value created by mgmt's decisions since inceptions. MVA = MV - IC
Difference b/t RI and EVA
RI is NI (after subtracting interest expense) - charge for equity capital based on the cost of equity; EVA is NOPAT (b/f subtract interest expense) - charge for both debt and equity captial based on WACC. However, they are both measuring eco income.
RI₁ = E₁ - (r x BVS₀); E₁: EPS for year 1
Single Stage RI Model
V₀ = B₀ + [ (ROE -r) * B₀ / (r-g) ] ; Need to know that implied growth rate can be calculated if re-arranging this formula.
Multi Stage RI Model
Persistence Factor: projected rate at which RI is expected to fade over the life cycle of the firm. High PF indicates low dividend payout and historical high industry PF; Low PF indicates high ROE, significant level of non-recurring items and high accounting accruals. V₀ = B₀ + PV of interim high-growth RI + PV of continuing RI; PV of continuing RI at year t-1 = RI at year T / (1+r-w) w is the PF; If RI persists forever then w =1 and plug in to above formula to derive PV of continuing RI. If RI declines to Long-Run level in Mature industry, then PV of continuing RI at year t-1 = (Pt -Bt +RI t) / (1+r); PV of continuing RI at year t = Pt -Bt;
Strengths: 1. TV does not dominate the intrinsic value estimate; 2. RI use accounting data which is usually easy to find; 3. applicable to firm with no dividends or positive/volatile CF; 4. focus on ECONOMIC profitability than on accounting profitability. Weakness: accounting data can be manipulated; need to have clean surplus relationship ( B₁ = B₀ + E₁ -D₁)
CFAT (Cash Flow After Taxes)
NOI - Debt Service - Tax Payable;
Tax Payable = (NOI - DEP - Int)
ERAT (Equity Reversion After Taxes)
NetSellingPrice - Mortgage balance - Taxes
if net selling price < original cost --> recaptured dep < accumulated dep;
if net selling price >= original cost --> recaptured dep = accumulated dep
Market Value of Income Property
1. direct income cap approach: MV = NOI/(r-g) = NOI / R₀
R₀ is the cap rate. 2. Gross income multiplier approach: MV = gross income
me * income multiplier.
Three Methods to Estimate Cap Rate
1. market extraction : R₀ = NOI/MV; 2. band of investment R₀ = Weighted Mortgage cost + Weighted Equity cost; 3 BuidUp: R₀ = pure rate + liquidity premium + recapture premium + risk premium