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Study Session 10: Equity Valuation: Industry and Company Analysis and Discounted Dividend Valuation

Risk premium and bond yield

There’s this question on the online question bank about determining the risk premium for a stock using the GGM, with a 1.5% adjustment for company size. This company’s revenues and earnings are cyclical in terms of both the business cycle as well as seasonality. After calculating the required return for the company’s equity, to get to the risk premium I subtracted the short-term government bond yield (since last time I subtracted the long-term yield and got it wrong, I was at that time told that the short-term is appropriate since the company is cyclical), wrong again….

ROIC - which formula to use?

What ROIC formula is everybody using? There are at least 3 described in the book:

  • In Reading 29 says the denominator is calculated as operating assets less operating liabilities  …… “invested capital” means book values and exclude cash
  • In Reading 29 footnote says invested capital includes cash and cash equivalents …. so include cash?
  • In Reading 32 says the denominator is total invested capital   ….. since TIC=MVIC this would imply to use market values

Sustainable Growth Rate

Does sustainable growth rate assume growth is generated through internal funds AND debt? or is it just internal funds?

Core Earnings

Trying to validate a possible error.

Company has trailing 12 month EPS of 20.57. 

Included in that number is a $0.45/share restructuring charge and a one time charge of $0.90/share for a one time expense. Both charges shouldn’t occur in the future. 

Should 12-month EPS based on underlying earnings be $19.22 or $21.92?

working capital needed for FCFF

In order to calculate working capital needed for FCFF, why would we take the change in all current assets (excluding cash) and current liabilities, do not the two include current non operational accounts?

EEM

I do not get to properties of the Excess Earnings Method:

1.The EEM allows for valuing working capital, fixed assets, and intangible assets using different discount rates.

How is that, how does it use different discount rates?

2. EEM is only rarely used in pricing entire private businesses.

Should not EEM a method of closely, privately held companies?

Constant Growth DDM

Why in some questions is the terminal growth rate not applied to the expected dividend? I get that you don’t need to apply a growth rate if they give you the expected dividend, but if there is a terminal growth rate (i.e constant growth after year 4) I was under the assumption you still apply that to the expected dividend?