# Study Session 9: Equity Valuation: Valuation Concepts

## FCFE when paying back debt

Hey Guys,

Just hammering out small details and found some inconsistencies in my notes

FCFE in the year you pay back debt, is it higher or lower?

I feel like it would be lower in the year you pay back debt (due to negative net borrowing) and then increase in the years after, due to the fact that you have lower interest cost but what happens to my net borrowing? Is it now lower offsetting any of the saving from the lower interest payment?

Any help would be appreciated

## Risk Free Rate for Multi Factor Models vs Build Up Models

Is my understanding correct? Below is what I’m seeing on mocks. I think knowing this concept will be good for a point or two on the exam.

Multi-Factor Models (have Betas): Use Short-Term Risk Free Rate

Build Up Models (No Betas): Use Long-term Risk Free Rate

## Ibbotsen Chen Equity risk premium

Hey guys,

A little help here

For the Ibbotsen Chen model [(1+inflation)x(1+RealGDPGrowth)x(1+Changes in PE)-1] +Yield of Market

Am I subtracting the risk free rate at the end?

Granted, almost all my notes say to do so…. But then I came across notes from my TT’S and CFAI mocks that say not to include it. Now I’m confused.

Which one is right? Is there a situation where I would include it and one where I wont?

Thanks for the help

## CAFI equity item sets

In CAFI equity item sets;

Stack questions Armishaw’s assumption in his 2014 valuation (Exhibit 2) that a perpetuity would best describe the terminal value of the stream and suggests that residual income should fade over time. Stack further suggests that a persistence factor of 0.50 might be appropriate.

**Q. **Using the information in Exhibit 2, comparing Armishaw’s approach to terminal value to Stack’s approach, Stack’s assumption leads to a 2024 value that is approximately:

## Residual Income (from CFAI Qbank)

From the vignette, “Raman collects additional data for valuing PBRI using the multistage RI model. For this model, he assumes an annual growth rate of residual income of 15% during the forecast horizon of 5 years (Years 1 to 5) and discounts the terminal year’s residual income as a perpetuity.” The question asks for the discounted value of terminal RI in Year 5.

I am not sure what year to use to discount the terminal RI back to the present. PV of cont. RI in year T-1 = RI in year T/(1+r-w)

## Calculating Risk Premium: ST Gov Debt vs LT Gov Debt

When you’re asked to calculate risk premium based on a number of factors and the vignette gives you both the return on short term government securities and long term government securities, do you always subtract your total equity return by the long term rate to find the premium?

## I am baffled by this question from IFT Mock (H-Model)

**Estimate the stock value using the H-Model**

Required return 13.2%

WACC 11.19%

Dividend payout ratio 40%

Most recent EPS $4.35

Current dividend growth rate (expected to persist 10 years) 12%

Growth will decline linearnrly to final and perpetual value of 5%

Current stock price $60

This is supposed to be a very simple question, but instead of finding D0 and proceed with using H-model formula, the answer uses EPS0 as D0. Am I missing something here?

## Equity Risk Premium

It is a silly question but there is different terminologies of equity risk premium;

1. What I have learnt is that it equates (beta*(mrkt risk-risk free)

2. Schweser some times use the equity risk premium for (mrkt risk-risk free)