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Study Session 9: Equity Valuation: Valuation Concepts

Debt to Equity ratio: market value or book value of equity?

Googling does not seem to provide a conclusive answer to this with a justification. I get that in a general sense, market values are preferred to book values because they represent more of a “real” sense of what equity is worth, but at the same time, the book value of equity is how much capital has actually been invested in a business. It’s what the company is actually working with. 

Background: My reason for asking this is I’m trying to find the WACC to discount cash flows for a private company using data from publicly-traded comparable companies.

Economies of Scale

Hello,

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.

Thanks,

How to calculate Expected Return?

Hey guys, 

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?

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?

Adding back interest tax shield to get FCFF

Hi guys, 

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?

Regards,

Porter's 5 Forces

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.

Struggling with Debt to Equity Fraction

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.

DDM share valuation

https://imgur.com/a/vEWq3LA

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?

Clarifying required return of equity vs. WACC concepts

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?