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13 Cards in this Set
- Front
- Back
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Differences in terminal value (TV) impolications |
TV estimates for abnormal earnings are smaller than for DCF or discounted dividend How beneficial this is depends on value reflected in BVE Accounting-based approach rests on how well accrual process reflects future CF Approach works best when accruals is unbiased, therefore, AEs are from underlying economics not accounting |
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What are the 2 impt issues in applying valuation theory? |
1. We need to make forecasts of financial performance over life of firm using either dividends, earnings or free cash flows 2. We need to estimate a cost of capital to discount these forecasts. |
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What are the subcomponents of the forecasting task? (2) |
1. Detailed forecasts over a finite no of years 2. Forecast of a TV |
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What is terminal value |
Abnormal earnings / Cash flows occurring beyond terminal year |
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Terminal value and competitive equilibrium assumption (3) |
Assumes sales growth is unlikely to exceed inflation in the LT Competition tends to constrain firm's ability to continually identify growth opportunities that will generate abnormal profits (Abnormal profits / earnings model TV is irrelevant) Some cos hv been able to earn abnormal profits for considerable lengths of time (Coca Cola, Apple) |
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TV and competitive equilibrium assumption on incremental sales only (2) |
If no abnormal profits can be earned on incremental sales beyond the terminal year, then any incremental sales beyond terminal year will add nothing to value of firm Assumes sales beyond terminal year same as terminal year |
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TV with persistent abnormal performance and growth (e.g. Apple, Coca Cola) (4) |
Project over a longer period OR Project growth in abnormal earnings ( / CFs) at some constant rate 'g' beyond terminal year. Then discount abnormal earnings in terminal year by r-g (must be +ve) Aggressive but realistic Supernormal profits can be extended only to an investment base that remains constant in real terms |
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TV based on price multiple assumptions (2) |
Assumes no sales growth, AEs / CFs beyond terminal year remain constant |
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Selecting the terminal year: How long? |
Assuming competitive equil model: - Earliest year when firm is no longer expected to ach abn earnings - firms should expect to revert to mean within 5-10 years - Exceptions: firms insulated from competition (brand power / monopoly) who can extend their investment base to new mkts for many yrs and still expect to generate supernormal returns |
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Cost of debt (4) |
Should reflect current interest rate(s) Net of taxes because aft-tax flows are discounted Mkt value of debt similar to bk value of debt Use firm's current mkt applicable interest rates |
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Cost of equity (3) |
Capital Asset Pricing Model May be combined with firm size Amount of leverage affects risk |
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What are 3 issues related to Value Estimates? |
Check assumptions used against time series trends for co's performance ratios Compare against stock prices of public traded cos Sensitivity analysis for diff economic scenarios |
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What issues have an impt effect on valuation (3)? |
Accounting distortions: affects book value and earnings Negative book values: huge investments with uncertain returns, look at BVA / share price / option value Excessive cash balances and cash flows: high likelihood of underinvestment, governance problems |
