# Study Session 9: Equity Valuation: Valuation Concepts

## Running out of time?

Anyone else feel like they are running out of time?

Currenty Still need to do:

Equity (just LOS 32,33,34)

Derivatives

CF

Econ

PM

Alt

Ethics

## Debt to Equity book error?

LOS 31 J - I am calculating the WACC.
Schweser says X’s “target debt-to-equity ratio is .25”

Does this mean that debt is 25% and equity is 75%?
The book says Debt is 20% and equity is 80%.
IS this an error? IF not whats an efficient way to learn how to convert ratios to percents

## EVA and EP

Is EVA and Economic profit the same? When reading Reading 33, they explained EVA with the same formula as EP.

## FCFF and interest income

To calculate FCFF, do we net out the interest income and expense?

Or is it just interest expense that gets added back to NI to come to FCFF?

On a side note, interest income is cash flow available to equity holders only, right?

And how does interest income effect FCFF and FCFE?

## Ibbotson Chen model

Hi,

Can someone please explain why are the variables used in Ibbotson chen model called supply-side variables? And if possible a comprehensive explanation for each variable i.e.

how does growth in EPS of a company define real GDP growth of a country?

Why is growth in P/E and growth in EPS included in it?

Do the following variables i.e. (1 + Einfl)(1+ ExpgrowthEPS)(1+ ExpGrowthP/E) -1] +EInc combine to form Rm from CAPM? If yes then how?

Thanks

## CFA Curriculum Reading 28 Return Concepts Q.9

Hi,

Q. In the current interest rate environment, using a required return estimate based on the short-term government bond rate and a historical equity risk premium defined in terms of a short-term govt. bond rate would be expected to :

• bias long-term required return on equity estimates upwards.
• bias long-term required return on equity estimates downwards.
• have no effect on long-term required return on equity estimates

What does all of this mean? Its so confusing.

## Realized Alpha

Hi,

So isn’t the formula for realized alpha = actual holding period return - Contemporaneous required return?

Because in a question its solved like this:  actual holding period return - required return of the same stock on a weekly basis.

## Required rate of return

Hi,

So when calculating required rates of return with average systematic risk (i.e. beta) are we supposed to use the geometric mean return relative to 10-year govt. bond returns over 10 years or yields of 10-year govt. bonds. Why do we use it (whichever it is)?

Also does average systematic risk means a beta of 1? and why?

Thanks.

## P/E vs Earnings Yield (E/P)

This phase is from Schewser: “Negative earnings render P/E ratios meaningless. In such cases, it is common to use normalized EPS and/or restate the ratio as the earnings yield (E/P) because price is never negative. A high E/P suggests a cheap security, and a low E/P suggests an expensive security, so securities can be ranked from cheap to expensive based on E/P ratios.”

Not quite sure I follow this.

If earnings is negative, using PE ratio is meaningless because it makes PE negative (okay get this part)…

## Justified leading vs trailing PE and undervalued vs overvalued

If the industry has a justified leading PE of10 and while the stock has a justified leading PE of 12, then obviously the stock is overvalued (expensive).

However, I just ran into a question where the justified trailing PE for the industry is 10, while the stock’s justified trailing PE is 12 – answer explained that the stock was undervalued but it didnt give further explaination.

Is this because trailing PE already occurred so the comparison is the opposite of justified leading PE?