## Info

Franchise P E value FF x G 2.31 x 10.11 23.35 intrinsic P E value tangible P E value + franchise P E value 10.00 + 23.35 33.35 The firm has a competitive advantage in its industry because its ROE is greater than its required return. By raising the retention ratio from 50 to 70 , thereby reinvesting more funds in the business, the firm can further exploit that competitive advantage, raising its franchise P E, its intrinsic P E (from 14.30 to 33.35), and its share price. This assumes that the...

## Residual Income Paid To Bondholders

Or (3) the analyst takes a corporate control perspective. Make sure you see the parallels between the free cash flow framework and the discounted dividend framework (i.e., the basic free cash flow model is analogous to the Gordon growth model). Memorize the formulas for FCFF and FCFE. This is a very popular test topic at Level 2, as many analysts prefer free cash flow models to dividend discount models. LOS 42.a Define and interpret free cash flow to the firm (FCFF) and free cash flow to equity...

## Jamie Johnson Has Been Asked Her Supervisor To Evaluate The Value

Use the information below to answer Questions 1 1 through 16. Jamie Johnson, CFA, has been asked by her supervisor to evaluate the value of two stocks in the recreational vehicle industry, AAA Motorhomes (AAA) and Thr e Star Travelers (TST). Johnson compiled analyst information for the two companies in Table 1. The market is expected to earn 11 in the next period, and the risk-free rate is 4 . Johnson's supervisor has requested that Johnson focus on dividends in estimating the value of the two...

## Momentum Indicators

LOS 43.o Describe the main types of momentum indicators and their use in valuation. Momentum indicators relate either the market price or a fundamental variable like EPS to the time series of historical or expected value. Common momentum indicators include earnings surprise, standardized unexpected earnings, and relative strength. Unexpected earnings or earnings surprise is the difference between reported earnings and expected earnings earnings surprise reporred EPS - expected EPS This is...

## Wacc

After-tax weighted average cost of capital in decimal terms net working capital + net fixed assets book value of long-term debt + book value of equity Professor's Note Notice the difference in calculation between residual income and EVA. Residual income is net income (after subtracting interest expense) minus a charge for equity capital based on the cost of equity. EVA is NOPAT (before subtracting interest expense minus a charge for debt and equity capital based on the WACC). Conceptually,...

## Answers challenge Problems

C Vadoom's thin margins are most likely rhe result of bargaining power of buyers. The firm faces high fixed costs, low marginal costs, and deals with buyers who represent a significant proportion of firm revenues, all of which tend to increase bargaining power of buyers. We have no indication that suppliers have significant bargaining power since Vadoom represents many equipment manufacturers. The high capital investment required is likely to deter new entrants. 8. A Price cutting is generally...

## Residual Income Valuarion

The CFA Institute Learning Outcome Statements are listed below. These are repeated in each topic review however, the order may have been changed in order to get a better fit with the flow of the review. The topical coverage corresponds with the following CFA Institute assigned reading The candidate should be able to explain how the classic works on asset valuation by Graham and Dodd and John Burr Williams are reflected in modern techniques of equity valuation, (page 13) The topical coverage...

## Los 451

Residua income models are appropriate under the following circumstances A firm does not pay dividends, or the stream of payments is too volatile to be sufficiently predictable. Expected free cash flows are negative for the foreseeable future. The terminal value forecast is highly uncertain, which makes dividend discount or free cash flow models less useful. Residual income models are not appropriate under the following circumstances The clean surplus accounting relation is violated...

## General Valuation Issues For Private Equity

Public firms are bought and sold on regulated exchanges daily. Private firms, however, are bought by buyers with specific interests at specific points in time, with each potential buyer possibly having a different valuation for the firm. Furthermore, valuing a private firm is more difficult than valuing public firms because as discussed previously, PE firms often transform and reengineer the portfolio company such that future cash flow estimates are difficult to obtain. Private Equity Valuation...

## Self Test Alternative Investments

Use the following information to answer Questions 1 through 6. Eva Williams is an investment manager for Straughn Capital Management (SCM). Williams believes that it would be beneficial to add some real estate investments to SCM's existing portfolio. She has asked a local real estate broker, Steven R.ley, to present some investment ideas to her. Riley is not certain which type of property might be most suitable for SCM, so he has prepared information regarding three different types of...

## Key Concepts

The sources of value creation in private equity are (1) the ability ro reengineer the firm, (2) the ability to obtain debt financing on more favorable terms, and (3) superior alignment of interests between management and private equity ownership. The tax savings from the use of debt is thought to benefit private equity firms. Private equity firms have a reputation for efficient management, high financial leverage, and timely payment of debt interest that limits concerns over their risk of...

## Implementing The Free Cash Flow Valuation Approach

LOS 42.j Discuss the single-stage (stable-growth), two-stage, and three-stage FCFF and FCFE models (including assumptions) and explain the company characteristics that would justify the use of each model. The single-stage FCFF model is analogous to the Gordon growth model discussed in the previous topic review on dividend valuation models. The single-stage FCFF model is useful for stable firms in mature industries. The model assumes that (1) FCFF grows at a constant rate g forever, and (2) the...

## Challenge problems

EBEE is expected to grow at a rate of 30 for the next five years. After that, competition is expected to lower EBEE's growth to a constant 7 indefinitely. The market risk premium is 6 , and the risk-free rate is 5 . EBEE's beta is 1.2, and the company just paid a dividend of 2.50. The current srock value of EBEE is closest to 18. Beta Forever Inc. manufactures and distributes a line of VCRs. The company has fallen on hard times and although it will pay a 4 dividend in the next period, it...

## The Five Competitive forces That Shape strategy

Jn 1979, Michael Porter introduced the concept of the five forces that shape competitive strategy. A recent update to this influential work shows how the five forces can be employed for strategic analysis. For the exam, know each of the five forces and how these combine to drive industry profitability. Describe why some factors that are commonly used in industry analysis have only a temporary effect on the forces that determine profitability in the long-run. Finally, be prepared to show how the...

## Rl

B0 current book value r required return on equity Valuation with residual income models is relatively less sensitive to terminal value estimates than dividend discount and free cash flow models. This is because intrinsic values estimated with residual income models include the firm's current book value, which usually represents a substantial percentage of the estimated intrinsic value. The Fundamental drivers of residual income are ROE in excess of the cost of equity and the earnings growth...

## Income Property analysis and Appraisal

The main points to take away from this new material for Level 2 on real estate appraisal arc the direct income capitalization approach an application of rhe Gordon growth model to real estate and the gross income multiplier approach a version of relative valuation from Topic Review 43 for real estate appraisals. For the exam, know the three different methods used to estimate a capitalization rate and when each of these is appropriate. LOS 47.a Explain the relationship between a real estate...

## Fcff And Fcfe Calculations

LOS 42.d Discuss the appropriate adjustments to net income, earnings before interest and taxes EBIT , earnings before interest, taxes, depreciation, and amortization EBITDA , and cash flow from operations CFO to calculate FCFF and FCFE. You are in danger of being buried alive by formulas in this topic review. We'll show you the ones you need to know for this LOS without showing you the derivations you're welcome . The basic idea is that we can arrive at FCFF by starting with one of four...

## Private equity valuation

This is a new topic review this year and has a great deal of testable material, both conceptual and quantitative. For the exam, know the three sources of value creation in private equity. Know that, relative to buyout firms, venture capital concerns firms that are immature and generally more risky. Understand that the drivers of return for buyouts are earnings growth, the increase in multiple upon exit, and the reduction in the debt whereas for venture capital firms, it is the pre-money...

## Concept checkers

The stock of Western Graphics Co. paid a dividend of 0.40 per share last year on earnings of 1.00 per share. The firm's earnings and dividends are expected to grow at 5 per year forever. Shareholders require a return of 12 on their investment. The justified trailing and leading P.'E multiples are closest ro 2. An analyst is valuing an electric utility with a dividend payout ratio of 0.65, a beta of 0.56, and an expected earnings growth rate of 0.032. A regression on other electric utilities...

## Lbxl g

net profit margin X justified trailing P E Example Calculating justified P S ratio A stock has a dividend payout ratio of 40 , a return on equity ROE of 8.3 , an EPS of 4.25, sales per share of 218.75, and an expected growth rate in dividends and earnings of 5 . Shareholders require a return of 10 on their investment. Calculate the justified P S multiple based on these fundamentals. The ratio E0 S0 is the profit margin. In this example, the profit margin is 4.25 218.75 0.0194. Therefore we get...

## The equity Valuation Process

This topic review is an introduction to equity valuation topics that arc covered in much more detail elsewhere in die Level 2 curriculum. Read this quickly to get the big picture, and then spend most of your time in the other topic reviews. The only two concepts unique to this topic review are alpha and the role of ownership perspectives in valuation. You should be able to define and calculate abnormal or alpha returns on both an ex ante and an ex post basis. You should also be able to discuss...

## Accounting Issues With Residual Income Models

LOS 45.m Discuss the major accounting issues in applying residual income models. Professor's Note This section is really just a brief summary of all the financial statement analysis material in Study Sessions 5, 6, and 7. As an analyst, your job is to take financial statements prepared according to GAAP, convert them to something that better reflects economic reality, and use these updated statements to estimate value. Here we discuss the typical adjustments necessary to implement residual...

## Fcff

The most appropriate model for valuing Outmenu is the A. free cash flow to equity model. C. free cash flow to the firm model. 24. Suppose an analyst uses the statement of cash flows to calculate free cash flow to the firm FCFF as cash flow from operations less fixed capital investment, and free cash flow to equity FCFE as FCFF plus net borrowing. The firm has short- and long-term debt on its balance sheet. Has the analyst correctly stated, overstated, or understated FCFF and FCFE 25. An analyst...

## Continuing Residual Income

LOS 45.h Explain continuing residual income, list the common assumptions regarding continuing residual income and justify an estimate of continuing residual income at the forecast horizon given company and industry prospects. Previously, we mentioned the problem of forecasting residual income indefinitely into the future, which makes it difficult to calculate the present value of residual income and implement the residual income model. However, we can simplify the model by using the same...

## Tings Cash Flow From Operations Forecast

Cash Flow From Operations Forecast for 2008 Fixed capital investment is equal to capital expenditures because there are no asset sales , which is equal to the change in gross PP amp E Working capital investment is the change in the working capital accounts, excluding cash and short-term borrowings WCInv AcctsRec2008 Inv2008 - AcctsPay2008 - AcctsRec2007 Inv2007 - AcctsPay2007 WCInv 30 40 - 20 - 15 30 - 20 50 - 25 25 Given that depreciation is the only noncash charge, we can calculate FCFF from...

## Discounted Dividend Valuation

This topic review presents the use of dividend discount models, one of the classes of models using the present value of future cash flows to determine the value of a firm. Dividend discount models use forecasted dividends as the estimate of cash flow to the shareholder. This material has shown up on every Level 2 exam in recent years, and there are several important topics that will require careful study. Vou should be able to choose the appropriate model for the firm to be valued based on the...

## Residual Income Using Fcfe

This pattern is not predestined, since many firms are successful in constantly adapting and entering into new growth opportunities. Mature firms may develop technology that forms the basis for a whole new product and market. The point is that a multistage model is required in order to value many firms. Fortunately, the GGM is easily adaptable to multistage growth. LOS 41.1 Explain terminal value and discuss alternative approaches to determining the terminal value in a discounted dividend model....

## O O300

V0 fundamental value D0 dividend just paid D, dividends expected to be received at end of year I r required return on equity g dividend growth rate The firm expects to pay a dividend, Dr in one year. Dividends grow indefinitely at a constant rate, g which may be less than zero . The growth rare, g, is less than the required return, r. A firm's growth rate projections can be compared to the growth rate of the economy to determine if it can continue indefinitely. It is unrealistic to assume that...

## Anson Ford Sting Fcff

- Common stock issues repurchases After-tax interest expense is classified as financing outflow rather than operating outflow Calculating FCFF from EBIT. FCFF can also be calculated from earnings before interest and taxes EBIT FCFF EBIT x 1 - tax rate Dep - FCInv - WCInv where EBIT earnings before interest and taxes Dep depreciation If we start with earnings before interest and raxes EBIT , we have to add back depreciation because it was subtracted out to get to EBIT However, because EBIT is...

## Sustainable Growth Rate

LOS 4l.o Define, calculate, and interpret the sustainable growth rate of a company, explain the calculation's underlying assumptions, and demonstrate the use of the DuPont analysis of return on equity in conjunction with the sustainable growth rate expression. The sustainable growth race SGR is the rate at which earnings and dividends can continue to grow indefinitely, assuming that the firm's debt-to-equity ratio is unchanged and it doesn't issue new equity. SGR is a simple function of the...

## 2. The Current Stock Price Of Mcd Is 89.00. The Current Dividend For Mcd Is 2.50 And Dividends Are Expected To Grow At

JCI Incorporated pays an annual dividend of 5.00 Canadian dollars C . The company is expected to continue paying this dividend with no future growth in dividends. Investors require a 9 rate of return on this investment. The current risk-free rate is 4 . The current stock value of JCI Incorporated is closest to 4. The current stock price of MCD is 89.00. The current dividend for MCD is 2.50, and dividends are expected to grow at a constant rate of 8 . The required return for MCD is closest to...