(This is starting on page 256, CFAI Equity Boook 4) I am unclear at this point what I am expected to do with emerging markets valuation! Schweser gives an example in Book 4 involving calculating Nominal and Real NOPLAT, Nominal/real WACC, Nominal/Real invested capital, using various givens like “ratio of revenue to EBITDA is 30%.” But then in a little paragraph it says you won’t be required probably to calculate these things; you’ll probably be given an item set and be asked to interpret. Do you need to memorize: Step 1: Forecast Operating Performance in Real Terms Step 2: Build Financial Statements in Nominal Terms Step 3: Build Financial Statements in Real Terms Step 4: Forecast the Future Free Cash Flows in Real and Nominal Terms from the Projected Income Statements and Balance Sheets Step 5: Estimate the DCF Value in Real and Nominal Terms as the steps to solving the problems?
I’m not spending my time and brainspace on it…which means it will probably show up for sure
I’m just sticking to the LOS statements for that section
this fking part is the most difficult in all equity. I want CFAI to remove porter stuff and include that in level I.
I am probably going to leave this one.
Chalked up as a loss. All I remember is that to calculate REAL WACC you have to convert from nominal (can’t just go real to real). Don’t ask me why… have no idea.
Wow even Swaption is stumped?! Huh…
I took this from a poster last year. Study this and I think you will be fine: 1. Emerging Markets often have high inflation and therefore we need to value differently. One important note: Ratios based on cash flow forecasts in real terms are accurate while ratios based on nominal forecasts are incorrectly estimated 2. Must match apples to apples, therefore must estimate real cash flows at real rate and nominal cash flows at nominal rate. Remember that both estimates will arrive at the same value. 3. Three issues that require attention: – Income taxes are paid based on nominal earnings, not real earnings. —The real cash outflow from NWC is not equal to the change in real NWC. ----Nominal capital expenditures are difficult to forecast using an assumed relationship between nominal sales and nominal capital expenditures because the relationship is not constant when inflation is high. The steps in valuing an emerging markets company on a real and nominal basis are: Forecast real revenue, EBITDA, invested capital, and EBITA. Forecast nominal revenue, EBITDA, invested capital, and NOPLAT. Forecast real NOPLAT (which is EBITA *(1-T)) Forecast nominal and real free cash flows. Estimate firm value using a free cash flow model in both real and nominal terms by discounting real cash flows at the real WACC and nominal cash flows at the nominal WACC. 4. There are two ways of incorporating emerging market risk into the valuation process. The first is to adjust the cash flows in a scenario analysis, and the second is to adjust the required return. There are four arguments that support adjustments to cash flow rather than adjusting the discount rate: a) Country risks are diversifiable (and so not reflected in WACC) b) Companies respond differently to country risk. (a shoe company may be more volatile than a steel company) c) Country risk is one-sided risk. d) Identifying cash flow effects aids in risk management. 5. Use the following guidelines to estimate WACC for an emerging markets company: The risk-free rate equals 10-year U.S. government bond yield plus the inflation differential between the local economy and the U.S. Beta is estimated as the industry beta from a globally-diversified market index. The long-term global market risk premium is approximately 4.5% to 5.5%. Pre-tax cost of debt equals the local risk-free rate plus the credit spread on comparably-rated U.S. corporate debt. Marginal tax rate should reflect local taxes that are applied to interest expense on debt. Capital structure weights are approximated by industry average weights. 6. If we’re using unadjusted cash flows to value an emerging market company, we need to add a country risk premium to the company’s WACC in order to arrive at the appropriate discount rate to reflect the extra risk associated with the emerging market. Unfortunately, there are no simple metrics for estimating this country risk premium, so instead you should be aware of some important issues to take into account when estimating the country risk premium. Do not use the sovereign risk premium to estimate the country risk premium. The reason is that the volatility specific to the company’s cash flow will usually be different than the volatility of government bond payments. Recognize that country risk premiums will vary widely across different analysts, so you need to understand the underlying forecasts that are part of the valuation analysis. For example, high country risk premiums are often associated with aggressive growth forecasts. The larger forecasted cash flows are therefore discounted at a higher cost of capital, and the result is a value estimate similar to that supplied by an analyst using a lower country risk premium and lower growth forecasts. Analysts often overestimate the country risk premium, so make sure you understand the valuation implications of a significantly higher than normal country risk premium. One way to do that is to compare the expected returns implied by the CAPM model to historical real returns in the country.
CLT2 Wrote: ------------------------------------------------------- > I took this from a poster last year. Study this > and I think you will be fine: > > 1. Emerging Markets often have high inflation and > therefore we need to value differently. One > important note: Ratios based on cash flow > forecasts in real terms are accurate while ratios > based on nominal forecasts are incorrectly > estimated > > 2. Must match apples to apples, therefore must > estimate real cash flows at real rate and nominal > cash flows at nominal rate. Remember that both > estimates will arrive at the same value. > > 3. Three issues that require attention: > – Income taxes are paid based on nominal > earnings, not real earnings. > —The real cash outflow from NWC is not equal to > the change in real NWC. > ----Nominal capital expenditures are difficult to > forecast using an assumed relationship between > nominal sales and nominal capital expenditures > because the relationship is not constant when > inflation is high. > > The steps in valuing an emerging markets company > on a real and nominal basis are: > > Forecast real revenue, EBITDA, invested capital, > and EBITA. > Forecast nominal revenue, EBITDA, invested > capital, and NOPLAT. > Forecast real NOPLAT (which is EBITA *(1-T)) > Forecast nominal and real free cash flows. > Estimate firm value using a free cash flow model > in both real and nominal terms by discounting real > cash flows at the real WACC and nominal cash flows > at the nominal WACC. > > > 4. There are two ways of incorporating emerging > market risk into the valuation process. The first > is to adjust the cash flows in a scenario > analysis, and the second is to adjust the required > return. There are four arguments that support > adjustments to cash flow rather than adjusting the > discount rate: > > a) Country risks are diversifiable (and so not > reflected in WACC) > b) Companies respond differently to country risk. > (a shoe company may be more volatile than a steel > company) > c) Country risk is one-sided risk. > d) Identifying cash flow effects aids in risk > management. > > 5. Use the following guidelines to estimate WACC > for an emerging markets company: > > The risk-free rate equals 10-year U.S. government > bond yield plus the inflation differential between > the local economy and the U.S. > Beta is estimated as the industry beta from a > globally-diversified market index. > The long-term global market risk premium is > approximately 4.5% to 5.5%. > Pre-tax cost of debt equals the local risk-free > rate plus the credit spread on comparably-rated > U.S. corporate debt. > Marginal tax rate should reflect local taxes that > are applied to interest expense on debt. > Capital structure weights are approximated by > industry average weights. > > > 6. If we’re using unadjusted cash flows to value > an emerging market company, we need to add a > country risk premium to the company’s WACC in > order to arrive at the appropriate discount rate > to reflect the extra risk associated with the > emerging market. Unfortunately, there are no > simple metrics for estimating this country risk > premium, so instead you should be aware of some > important issues to take into account when > estimating the country risk premium. > > Do not use the sovereign risk premium to estimate > the country risk premium. The reason is that the > volatility specific to the company’s cash flow > will usually be different than the volatility of > government bond payments. > > Recognize that country risk premiums will vary > widely across different analysts, so you need to > understand the underlying forecasts that are part > of the valuation analysis. For example, high > country risk premiums are often associated with > aggressive growth forecasts. The larger forecasted > cash flows are therefore discounted at a higher > cost of capital, and the result is a value > estimate similar to that supplied by an analyst > using a lower country risk premium and lower > growth forecasts. > > Analysts often overestimate the country risk > premium, so make sure you understand the valuation > implications of a significantly higher than normal > country risk premium. One way to do that is to > compare the expected returns implied by the CAPM > model to historical real returns in the country. thanks, it really summed up the whole topic, but i am still afraid that i may have to calculate such thing the real exam !!!
I think EM valuation was on the exam for Asian counties last yr.
They did, I couldn’t find much on how exactly it was tested but here’s what one poster said: Re: was there really an EM vignette overseas? Posted by: DblA (IP Logged) [hide posts from this user] Date: June 11, 2008 03:24PM Yes I had the emerging markets section in New Zealand. I think only 3-4 questions from the vignette? One question was so confusing I just had to guess. They tended to focus on the impacts of inflation and real vs nominal sales etc. impact on ratios. I had done a small amount of revision on EM but could only guess in the end. Sorry for lack of detail but the whole exam is a bit of a blur.
Emerging markets is going to an important issue. I guess memorize the Schweser material. It could show up in a valuation in Cap Bud or PM in Emerging markets. I guess the major point would be effect on ratios rather than calculations…