Note 3 - CFA prep PDF

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T/F: the residual income model is based on a going concern assumption - T (reading 24)

T/F: the residual income valuation method is the most sensitive to terminal value estimates - F relatively less sensitive

T/F: unlike other models, the residual income model relies on accounting data which is easy to find - T - but we need to make adjustments

T/F: using a P/B multiple does not reflect intangible economic assets - T (157)

T/F: WACC is typically higher for private firms - T

T/F: when acquiring a private firm, the larger firm should use its WACC to value the target - F the acquirer should use the higher rate appropriate for the target

T/F: when using the Guideline Transactions Method, adjust the historical transactions for an equity control premium - F - do not need to adjust

the dividend yield is ------ related to the req rate of return and ------ related to the forecast growth in dividends - positive negative

the equity risk premium is (higher/lower) during a recession - higher

the justified P/E is ------- related to growth rates and ------- related to the required rate of return positive negative

The PRAT model is another word for the DuPont formula. What do the letters stand for? - Profit margin Retention rate

Asset turnover T (financial leverage)

the residual income valuation model breaks the value of a stock into 2 elements - what are these? - 1. current book value of equity 2. present value of expected future residual income

The single stage FCFF model is analogous to the ------ model. - gordon growth

transaction related valuations are usually performed by...... - investment bankers

two ways to estimate the risk premium of an EM market? - 1. country spread model - uses DM and adds a risk premium using the spread in bond yields 2. country risk rating mode - estimates an equation for the equity risk premium for a DM, then uses EM inputs

under which MM proposition is the capital structure irrelevant? - MM proposition I (no taxes) & II (no taxes)

what are "top down", "bottom up" and hybrid approaches used for? - estimating inputs for equity valuation models

what are "underlying earnings"? - consistent, continuing, or core earnings

what are 2 examples of a NCC? - depreciation and amortization

what are 2 other names for the capitalized cash flow method? - capitalized income method, capitalization of earnings method

what are 2 standards suggested for private company vavluation? - USPAP and IVSC (258)

what are 3 methods to estimate the required rate of return for private firms? - CAPM, expanded CAPM, build up model

what are non cash charges (NCC) - expenses that reduced reported net income but didnt actually result in an outflow of cash

what are normalized earnings? - expected mid-cycle earnings aka controlling for the impact of the cycle

What are Porter's Five Forces? - Buyer power Supplier power Threat of substitute products or services Threat of new entrants Rivalry among existing competitors

what are some (5) common accounting issues when utilizing the residual income model? - 1. clean surplus violation 2. variations from fair value 3. intangible assets impact book value 4. nonrecurring items/aggressive accounting 5. international accounting differences

what are the 2 components of a firm's equity value? - 1. value of current assets (earnings/r) 2. PVGO

what are the 2 formulas for FCInv? - 1. FCInv = capex - proceeds from sales of long term assets 2. FCInv = ending net PP&E - beginning net PP&E + depreciation

what are the 2 important intangible assets for calculating residual income? - 1. intangibles recognized at acquisition 2. R&D expenditures

what are the 2 major causes of error in valuation analysis? - 1. estimating future growth in FCF 2. choosing a representative base year

what are the 2 ways to forecast revenue? - growth relative to GDP growth or market growth and market share

what are the 2 ways to incorporate a control premium under the GPCM valuation? - 1. use a raw multiple to estimate firm value, subtract debt, then add the control premium to the equity estimate 2. begin with the equity control premium, then adjust for valuation using the MVIC multiple

what are the 3 major approaches to private company valuation? - 1. income approach 2. market approach 3. asset-based approach

what are the 3 methods consistent with the income approach of private company valuation? FCF (aka DCF), capitalized cash flow, residual income (excess earnings)

what are the 3 methods of market based valuation for private companies? - guideline public company method (GPCM), guideline transactions method (GTM), the prior transaction method (PTM)

what are the 3 multistage DDMs? - 1. two stage model 2. H model 3. three stage model

what are the 3 net agency costs of equity? - monitoring costs, bonding costs, residual losses

what are the 3 reasons for valuing a private firm? - 1. transactions 2. compliance

3. litigation

what are the 4 definitions of cash flow used in calculating a P/CF ratio? - 1. earnings plus non cash charges (CF) 2. adj cash flow (adj CFO) 3. free cash flow to equity (FCFE) 4. EBITDA

what are the 5 examples of transaction related valuation scenarios? - VC financing, IPO, sale in acquisition, bankruptcy proceedings, performance based exec comp

what are the steps in using the method of comparables valuation approach? - 1. select the multiple to be used 2. select the benchmark and calculate the mean or median of the multiples of a group of comp stocks 3. compare the company's multiple with the benchmark mean/median

what are the three measures of future cash flow? - dividends, free cash flow, residual income

what are the three types of fair value? - 1. fair market value 2. fair value for financial reporting 3. fair value for litigation

what are TIPS? - us treasury notes that pay interest every 6 months and are indexed to the CPI (principal is paid at maturity)

what does "benchmark value of a multiple" mean? - the justified price multiple found by a method of comparables

what does PVGO stand for? - the present value of growth opportunities

what does the PEG (P/E to growth) ratio tell us - relationship b/w earnings growth and P/E

what happens to a company's operating margins when sales volume increases - if the company exhibits economies of scale - the operating margins increase aka are positively correlated with sales volume

what is "invested capital"? - operating assets - operating liabilities

what is "restriction on marketability" for a private firm? - some shareholders might have an agreement that prevents them from selling, reducing the marketability of the shares

what is $WACC? - WACC x invested capital

what is a "justified price multiple"? - the price multiple that should exist for a stock

what is a "predicted P/E" - a P/E estimated from linear regression of historical P/Es on fundamental variables

what is a clean surplus violation and when might it occur? - violation is when the ending book value =/= beg. book value + net income - dividends. This may happen when items are charged directly to shareholders' equity and don't go through the income statement

what is a contingent consideration? - the part of an acquisition price that is contingent on a specific external achievement

what is a synonym for residual income? - economic profit

what is another word for total invested capital (TIC) - market value of invested capital

what is continuing residual income? - res income that is expected over the long term

what is fair market value? - most often used for taxes, fair market value is a cash price characterized by an arm's length transaction with a willing and informed buyer/seller...