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Study Session 9: Equity Valuation: Valuation Concepts

Equity : Topic test Mckinley

Q.2. While calculating requires return with Fama french method, the risk free rate that has been considered is the short term instead of long term g-sec. 

What am I missing? And what should one do in exam?

Definition Free Cash Flow vs FCFF and FCFE

Hi all,

I am a little confused by the definition of Free Cash Flow. To me the concepts of Free Cash Flow to Equity and Firm are relatively clear, but I am not sure if there is a separate definition of Free Cash Flow. Most of the time the term seems to refer to either FCFF / FCFE where the content applies to both of them.

But for instance in the M&A chapter it seems to me that there is a separate term for FCF (where I can see no difference zu FCFF?). Is that so and if yes how is it defined and what is distinguishing it then from FCFF?



Schweser Practice Exams V1 Exam 2 Morning - Question 31 - Return Concepts

Should be a simple question but I got confused over it…

The vignette says:

Based on her extensive analysis, she determines that her expected return on the stock, given Taylor’s risks, is 10%. In applying the capital asset pricing model (CAPM), the result is a 12% rate of return.

Now the question asks if the stock is under/overvalued.

ROE calculation

In topic test, Equity- Alahtab 13 of 17

Question 1: 

According to Gordon growth model, calculate CRN’s value per share using 2013 sustainable growth rate as dividend growth.

In the answer, it use (Net Income in 2013 )/(equity in the end of 2013) to get ROE in 2013 to calculate growth rather than using beginning equity.

Why it use end of year data? When we are calculating justified PB ratio, the ROE in the formula is NI(1)/B0. And I just went through CFAI, I saw this paragraph,

cash flow from operations

If using the financial statements to calculate CFO- I know how to use the income statement to start from NI & back out non-cash- but I forget exactly how to handle the balance sheets? Don’t we just use the total of working capital over the previous ending total of working capital? (That would be the increase in working capital that year…but don’t we exclude accounts cash and notes payable? Why? And do we exclude accounts payable as well? or anything else?



Im given expected CAPM on annual basis of 12.6%, while P0=$20.75 and P3=$29 and the problem asks to solve for three-year holding period return.

Why 29/20.75-1 is not equal to (1+12.6%)^3? Im given annual required return of 12.6% so what’s wrong?

Industry and company analysis


Do we really need to do the BB examples for industry and company analysis? While the chapter seems fairly easy, the BBs are crazy lengthy and time consuming! 

What do you guys suggest? 

GGM model

If dividend declines at a constant rate indefinitely, is Gordon growth model still valid?

P/E ratio


Leading P/E=(payout ratio)/(r-g)

Therefore, as payout ratio increases, P/E increases.

However, g=ROE*(1- payout ratio)

As payout ratio increases, g decreases, then P/E decreases.

So, if payout ratio increases, whether P/E increases or decreases?