Study Session 9: Equity Valuation: Valuation Concepts
Will I get the same valuation if I discount free cash flows to the firm with WACC and subtract debt and add cash as if I discount free cash flows to equity using the cost of equity?
What will make the equity values differ?
How do we determine a company has economies of scale by looking at the financial statements?
I saw in the book, they say that operating margin and gross margin must be positively correlated, but i do not get the logic behind. Every time a economy scale type of question, I think we should just look at the cost of goods sold and S&A.
Can you please help me understand this? I don’t know if I’ve understood the case study wrongly or if there are inconsistencies with the calculation provided. (from the 2020 textbook)
On page 55,
P0 = 129.97, V0 = 176.3, r = 6.3%
Solution given: Expected Return = [(176.3 - 129.97)/129.97] + 6.3% = 44.07% —- (Price Appreciation + r)
On page 56,
P0 = 33.31, V0 = 37.5, Dividend = 0.96, r = 7%
How do you quantify the cost of equity?
The dividend is a tangible cost that makes up a small portion of the cost of equity and the cost of debt can be directly quantified by the interest paid on debt. But how do you quantify the cost of equity?
If you take a look at the formula for computing FCFF from EBITDA,
FCFF = EBITDA (1-tax rate) + Depreciation (tax rate) - FCInv - WCInv
you would notice we add back the depreciation tax shield because that tax saving represents cash available to the company’s investors.
Why then, don’t we also add back the interest tax shield in this formula?
I know this is something we all have seen at least 5 times in our undergrad courses, but does anyone else think it’s difficult to quantify/categorize one detail in a vignette into one of these forces? Anyone got any tips or tricks for this? I just feel this would be such a dumb question to get wrong when my margin for error is already low.
One thing minor I continuously seem to find myself struggling with is how to functionally convert D/E.
For instance, I was just working through an equity problem requiring to un-lever then re-lever beta. I knew the formula for both and was ready to go.
They presented D/E in two ways:
Target company: 40% Debt-to-total-capital
Actual company: 75% Debt-to-equity
I tried ten different inputs and couldn’t get the answer right.
Came across this solution for a share valuation using a DDM model. It seems that they disregarding the cash flows in the first 7 years, and only taking the PV of terminal value as the share price….why are we ignoring the initial cash flows? Am I missing something here?
I understand the formulas are different, but let’s say a company has no debt, would the required return of equity be the same as the WACC? Since required return of equity would essentially be the cost of capital for the company, would the two be the same conceptually?
1. Is there any difference between FC Inv = CAPEX ?
2. Is CAPEX = Ending Fixed assets - Beginning Fixed Assets - Depreciation?
Study together. Pass together.
Join the world's largest online community of CFA, CAIA and FRM candidates.