CFA Level 2 - Equity

Equity Value
investment value captures potential synergies of acquisition
fair value is the value between willing buyer and willing seller
intrinsic value is the true value of the company
going concern value : the value given that the company will continue its business activities into the foreseeable future.

Shaping strategy: best in unpredictable environment that a company has the power to change

Free Cash Flow model
FCFF = CFO + Interest(1-T) - FCInv
FCFF = NI + NCC - WCInv + Interest(1-T) - FCInt
FCFE = CFO + Net Borrowing- FCInv
FCFF is preferred over FCFE when company is leveraged and capital structure changes

In FCF calculation, WCInv does not include cash, notes payable, and current portion of debt, only include AP and AR.

Cash and marketable securities are NON-operating assets

V0 = FCFF1 / (rwacc -g)
Vequity = V0 - Vdebt

Equity Valuation
Discounted Dividend Valuation
  i) Gordon growth model: P0 = D1/(r-g)

  ii) H-Model
A variant of the two-stage dividend discount model, growth begins at a high rate and declines linearly throughout the supernormal growth period until it reaches a normal growth rate that holds in perpetuity.
V0=D0r−gL[(1+gL)+N2(gs−gL)]
gL - long term dividend growth rate
gS - initial dividend growth rate
N  - years where dividend decline in linear fashion

Free Cash Flow Valuation
  FCFF and FCFE valuation approach

Market based Valuation
  Price multiples, EV multiples

Residual Income Valuation
  Excess earnings methods(EEM)

Private Company Valuation
  Income Approach: FCF method, capitalised cash flow method, residual income method(EEM)
  Market Approach: Guideline public company method (GPCM),  Guideline transaction method (GTM)
  Asset Based Approach: the value of ownership of an enterprise is equivalent to the fair value of its assets - the fair value of its liabilities

discount for lack of control = 1 - 1/(1 + control premium)

EVA = NOPAT – (Cost of capital × Total Capital)  
MVA=Marketvalueofthecompany −Accountingbookvalueoftotalcapital




P/E ratio
justified trailing P/E = (1-b)(1+g)/(r-g)
justified forward P/E = (1-b)/(r-g)

We are assuming that earnings will grow at g:  E1 = E0 × (1 + g).

Thus, for trailing P/E we divide by a number (E0) that is smaller by a factor of (1 + g), so the ratio is larger by a factor of (1 + g); for leading P/E we divide by a number (E1) that is larger by a factor of (1 + g), so the ratio is smaller by a factor of (1 + g).

Keypoints
restructuring charges and employee stock option grants are included in core earnings

financial leverage does not affect EBITDA
EBITDA overestimates CFO if WC is growing
If EC increase (CA increase more than CL), the firm uses cash to build up the CA, CFO capture changes in WC, EBITDA does not capture changes in WC. So EBITDA overstates CFO when EC is growing

CAPM only incorporates market risk (beta)
FFM model is three factor model, Ri = Rf +  βrmrfFac1 +  βsmbFac2 +  βhmlFac3
smb is small minus big, if βsmb is 1, it is small size company (small cap)
hml is high minus low, book value to market value ratio, if βhml is 1 , it is value stock (high book to market value ratio)

The Rf is short term gov bill yield(risk free), long term bond has uncertainty
Pastor-Stambaugh model adds liquidity to FFM model (Fame French model)

PEG assumes linear relationship between P/E and growth, does not factor in risk.

core earnings includes restructuring charges and employee stock option grants

Blume's adjusted beta = (2/3)(unadjusted beta) + (1/3)*(1.0)

Enterprise Value
  EV = D + E - Cash - short term investment + minority interest
D = market value of debt
E =  market value of equity

Comparing firms with differences in international accounting stds:
less subject to accounting stds <------>  most subject to accounting stds
P/FCFE                       EV/EBITDA               P/E