Lecture 1: 4) Build on business’ existing strengths and tend to expand in services and products 6.

Efficiency Ratio: 13) (EV/EBITDAR)

which the company has reasonable competency and resources to deal with 5) 14) EV / EBIT (EV/EBIT)
Business Valn Definition: i) eco value of owner int in a biz ; ii) price that market
Diversifying into new products and new markets often seen as more difficult for 15) EV / Revenue (EV/R)
participants pay ; iii) A&L computation
company with organic growth strategy due to lack of prior knowledge and experience of 1) Operating Eff: Opr Ratio- (Opex+ COGS)/Net Sales 16) EV / Free Cash Flow (EV/FCF) (where FCF = EBITDA – Capital Expenditure +
FMV: Price at which willing buyer and seller neither under the compulsion and both
the market 6) Allow business to grow at a sensible and manageable rate in the long run 2) Financial Eff: ICR ; Decrease in Working Capital (– Increase in Working Capital)
having knowledge.
7) Have lower risk than growing through mergers and acquisitions 8) Focus on these to 3) Opr and Financial Eff= i) Asset Turnover (Activity Ratios or Asset Utilisation
FV(Business val)/Equitable Value: EV definition: Definition of FMV + reflects the
improve value: i) Brand and Promotion ii) Innovation and Product Development iii) Ratios): Total (Fixed) asset turnover)- Net Sales/Avg TA(Avg TFA) , WCT , ITR or
respective interest of the parties. Fair Value is the one which is just and equitable. This
Sales and Distribution iv) Customer Relationships v) Operations: Efficiency, DOI , ART or DSO ; ii) APT or DPO Pros and Cons of Different Valuation Ratios
definition within itself contains the concept of adequate compensation (indemnity).
Productivity and Quality
FV (Financial Reporting): Price to sell an asset or xfer liab between mkt participants at Lecture 2-2 (CCC, Overtrading,Mkt Based Valn
measurement date. (GAAP)
IV: Value that investor believes is true or real and will become price when other people
Approach): P/E: Pros: Commonly used and data easily avail ; Cons: EPS manipulated easily, can’t
start thinking same. 4- Enhance Business Value through Mergers use for loss making, EPS can be high due to one off events ; Best use: except loss EPS
Investment value: Value based on particular investor based on individual requirements Two “more or less equal size” companies merge together. Shareholders of the two PEG: Pros: Considers future potential ; Cons: Requires credible accurate forecasts,
and estimations for inv or opr. companies retain equity interest of the combined entity and management share the CCC: Calculates the amount of time taken to pay for inv and receive the money back. requires sensible risk and growth assessment ; Best use: High g companies
VIU: PV of future CF from asset or CGU. CGU is the small independent group of asset responsibility of running the combined organisation. 1) Try to gain market share Also measures the amount of time we have to finance the inventory. P/S: Pros: Can apply to loss-making companies, Data is relatively more objective, easy
that generate CF that are independent from other assets or group of assets. (Horizontal merger) . 2) Try to remain competitive when the market consolidate CCC is an impt short term financing metric that needs attention. to use ; Cons: EV/S is preferred to P/S ; Best use: Broad estimation
Liquidation Value: Value when assets are sold in piecemeal basis. Takes into acc the (Horizontal or Vertical merger). 3) Ensure supplies or distribution channels and CCC increases when DSO or DIO increases or when DPO decreases P/B: Pros: Easy to use ; Cons: Asset values may be manipulated and not represent the
costs involved in getting it into saleable condition as well as disposal activity. Two diff strengthen its value chain position (Vertical merger) There is a direct connection between CCC, a company’s profitability & stock true economic value ; Best use: Capital intensive industries and financial insti
premises of value: i) orderly transact with mkting period ; ii) forced transact with short market performance. Total asset turnover (TAT) = Net Sales/TA is a useful measure P/D: Pros: as floor price, compare cash return with other types of inv ; Cons: Depends
mkt period. and Lower cycle  lower investment in inventory & receivables  lower total assets on div policy which might be affected by tax legislation, constant growth assumed,
Business Value: Eco value of firm + societal, emp value, etc 5- Enhance Business Value through Acquisition (or Takeovers)  higher TAT (assuming net sales remain constant)! and Higher TAT  Higher cannot be applied for non-div paying firms ; Best use: to set floor price
Value Driver: Anything that can increase value of product and pay premium for it Friendly takeover normally termed as acquisition. Target company's management and ROE! P/CF: Pros: Data is more objective and less manipulable, Emphasizes CF instead of
board of directors agree to acquisition by the acquiring company. profit ; Cons: Must be assessed based on comparable companies to get the relative value
Takeover tends to refer to hostile takeover but not necessary in all cases as takeover ; Best use: Relative pricing comparison, Good for start-up evaluation
Methods in diff situations: M&A: fmv, mv, inv value ; restructuring: fmv, mv ; inv and acquisition are interchangeable nowadays.Target company's management and board What is overtrading?   EV/EBITDA: Pros: Is the most popular EV model, EBITDA is close to FCF, Is not
decision: IV, mv, inv ; tax: fmv mv ; judicial: fv , mv ; Fin Reporting: FV, viu, of directors reject the proposed acquisition. Acquiring company bypasses the rejecting When growth controls the business, rather than the business controlling growth, there affected by accounting policies on non-cash items ; Cons: Ignores capex and value
replacement, reproduction cost new ; Winding down: Liq Value parties and goes to shareholders directly by offering attractive premium so as to achieve may be trouble ahead. created by tax management and planning ; Best use: All except 0 or -ve EBITDA
Economic Analysis: General analysis, GDP, Infl, capital mkt conditions, money market sufficient shares to fight for replacement of the existing management and board of Overtrading is  where a business enters into commitments beyond its available short EV/EBITDAR: Pros: use when companies rent assets instead of purchase them ; Cons:
conditions (forex trend of LC and FC, govt bont yield, money and credit mkt condition) directors; and/or take over the control term resources. Typically, trying to make a profit with too little working capital Same as ev/ebitda + rent may not be disclosed ; Best use: hotels, trans, and retail
Life Cycle Analysis: underpinning the effort. Overtrading can be difficult to spot as it’s caused by time lags EV/EBIT: Pros: Highlights/Differentiates companies with high capital commitments ;
within the business model, not easily discernible to outsiders Cons: affected by dep policy; Best use: except 0 or loss making ebit
6- Enhance Business Value through Spinoff and Management Buyout Worse is – a company might not be aware they’re overtrading. It may be expanding to EV/R: Pros: Apply to loss-making companies, Data is more objective, easy to use ;
A company makes an independent subsidiary by selling/distributing new shares of get their way out of some underlying financial trouble! Cons: Rev may not be the key driver ; Best use: Min price setting, professional firms
existing company is called spinoff. such as acc and law firms (with high corr of earning with rev), new start-ups
When managers acquire a large part of the company, it is called management buyout. EV/FCF: Pros: Can better normalize impact for companies with intensive capital
Signs of Overtrading: requirements, Is not affected by accounting policies on non-cash item ; Cons: Capital
expenditure tends to be irregular items, leading to more difficult interpretation and lack
7- Enhance business valuation via early/diff stage venture or PE inv of consistency of figure. ; Best use: lower the ratio- more underval the company, start up
A cheaper form of investment and acquisition due to cheaper valuation valuation
Intro Growth Maturity Decline Risk Factors involved with different growth methods
PESTID: Pol, Eco, Soc, Tech, Innovation, Demo
Limitation of Rations:
SWOT: Opp and threat arise from ext organisations
Organic: Too slow compared to merged company so loss of mkt cap and large 1) Companies operate in different industries with diff market factors. There it might be
customer. Growth rate can be restricted by and dependent on overall g of market. misleading to compare ratios of companies in diff industries. 2) Diff accounting policies
M&A: Most M&A fail to achieve the estimated synergy. used by different companies which might impair comparability and ratio analysis, 3)
How to create value for all the stakeholders?: Ratio analysis in general explains relationships between past information while users
1) Increase sustaining business value through the good governance and risk Venture & PE: High failure rate, constant change of direction and plans, constant
request for new injection of funds by start-up, potential dilution effects are more concerned about current & future information
management mechanism to ensure effective use of these capitals:
Financial capital – e.g. shares, bonds, cash and cash equivalents ; Manufactured Lecture 2-1 (Ratio Analysis): Lecture 4 (Asset & Income Based Valuation Approach)
capital – e.g. machines, buildings, non-current assets ; Human capital – e.g. people 1. Profitability Ratios:
and their knowledge, skills, motivation ; Intellectual capital – e.g. brands, intellectual
properties, patents ; Natural capital; and – e.g. environment related renewable and non-
GPM=
GP OPM=
EBIT NPM= 1. Cost Approach (ABV):
renewable resources and processes ; Social capital – e.g. human relationships, co-
operation, networks, families, schools, social media
2) Improve sustainability practices and triple bottom lines: Economics,
Net sales Net Sales Signs of Overtrading:
1) Inject new equity funding, if possible Meaning: Assume buyer will not pay more than the cost of assets for the business. It is
Environmental, Social (EES)
¿ ROIC=
NOPAT 2) Manage supply chain (and suppliers) carefully and negotiate better payment terms
which can often make or break a business’s ability to meet demand, without running
based on the BV (with suitable adj) of the assets: Net Asset Value Approach, also
known as Net Asset Backing Approach, Asset Accumulation Method, Asset Build-up

9 value Drivers: 1) Next-Level Management Operating Systems Demonstrated to

Net Sales Avg Invested Capital itself dry
3) Obtain short term business loans and more favourable credit terms from suppliers
Method, Adjusted Book Value Method, Adjusted Net Asset Approach.
Used for cross checking and setting a floor pice. Valn Adjs depends on: 1) Going
Increase Sustainability of Cash Flows 2) Diversified Customer Base (i.e. not too
concentrated) 3) Proven Growth Strategy 4) Recurring Revenue That Is Sustainable and
ROCE=
NOP∨EBIT ROA=
¿ ROA=
4) Replenish funds as fast as possible by offering early and prompt payment discounts
to incentivize customers to make payment early or promptly
concern: MV of assets and liabilities as a going concern business and 2) Liquidation
(break-up basis): MV of A&L in liquidation ; NRV (incl tax impli) ; liqui cost
Resistant to “Commoditization” 5) Good and Improving Cash Flow 6) Demonstrated
Scalability 7) Competitive Advantage 8) Financial Foresight and Controls Avg Invested Capital Avg TA 5) Manage working capital carefully, especially on inventory, accounts receivable, and
cash
allowance

¿ Choosing a valuation base for assets: 1) Historical Cost: Appropriate for CAs with
UNDERSTANDING VALUE DRIVERS
1- Understated Value Driver: Cash and cash flow management: Avg Shareholder Eq Mkt Based Valuation Ration: fast turnover, trade receivables (subject to allowance for doubtful debts) ; 2)
Replacement Cost: Assets are used continually within the business (e.g. Raw material
1) Role of Cryptocurrency (e.g. Bitcoin)? 2) Bank relationship and credit facilities inventories) ; 3) Net Replacement Cost: Non-current assets carrying at net book
management- Multi-bank approach or focus on small number of bankers? 3) Treasury Prev already stated ratios: 1) EPS= (NI-Pref Div)/wtd avg, 2) Div yield= DPS/Price, 3) values in the financial statements (eg: equipment & machinery). It is just the full
management- Centralized treasury management – e.g. centralized cash management 1) where Net Sales = Revenue after deducting: Sales Tax, Discounts & Sales Returns BV/share, 4) MV/share, 5) CF/share, 6) P/E (ttm and ntm) replacement cost minus allowance for depreciation to recognise the age of the asset. 4)
including foreign currencies OR Use bank’s treasury management services? 4) Money 2) where Capital Employed (CE) = TA – Current Liab Or CE = Eq + LT Debts NRV: Apt for assets have readily available markets such as properties, motor vehicles,
market funds and financial instruments: For profits or cash management and ST 3) where NOPAT = EBIT * (1 - Tax) ; Invested Capital = CE – Non-operating assets commodities held as inventory
investments using financial instruments (e.g. cash, share investment) Normal New:
4) When companies are from different tax regimes- use ROCE ; else, ROIC 7) PEG: PE/EPS growth (or PE/{[(EPSn-EPS0)^(1/n) – 1]*100)} ; 8) PS: MP/Sales per
sh ; 9) P/B ; 10) P/D= MP/Div per sh ; 11) P/CF: MP/CF per sh Under Going Concern: Value of 100% Eq= Net assets + Inc mkt value of the property
2- Regularly Understated Value Driver: WC Management: - income tax on the sale of property
1) Inventory and logistic management: i) Outsourcing (third party logistics), 2. ROE Decomposition: Under Liq: First calc NAV by doing (BV +- any value adj) and getting the mkt value.
insourcing or part of company’s daily operations? ii) Vendor inventory management and ROE= NPM x Assets Turnover x Equity Multiplier EV= Mkt Cap + NET Debt + Minority Sh (or minority interest) + Pref Shares – C&CE Then adding it to get NAV. Then subtract liq cost to ger the 100% eq value.
Just-in-time/lean management 2) Accounts receivable management: i) Restructuring
of sales commission based on received rather sales ii) Factoring or invoice discounting
iii) Accounts receivable insurance iv) Incentives for on-time and prompt payments e.g. ROE=
Net income x
Net Sales x Avg .TA EV= Net Debt + Equity – C&CE
EV= Operating Assets= Fixed Assets + Intangible Assets + WC
10) EBITDA Multiple: EV/EBITDA
Prompt payment discount? 3) Accounts payable management: i) Vendor and supply
chain management ii) Obtain trade credit whenever possible iii) Compare days in
Net Sales Avg .TA Avg . TE
payable outstanding (creditor days) and days sales outstanding (debtor days) iv) Monitor 1) NPM- Measure of opr eff ; TAT- Asset use eff; EM- Measure of LT solvency
2) Only invest more in A when the TAT & PM is greater than B. But if it is only Pros
cash conversion cycle and net working capital position - This ratio does not consider tax therefore is useful for cross countries comparison
because of EM, then we would not cus we are exposing ourselves to bankruptcy risks
3. Mkt Based Ratios when companies under different tax regimes
- This ratio explicitly considers the debt value and other funding sources therefore is
3- Enhance Business Value through Organic Growth and Capital Investments good for mergers and acquisitions consideration to check the real value for the whole
enterprise
 EPS=
Net Income−Preferred dividends P/E Cons
- It is not fair to use it for cross-industry analysis because different industry requires
1) Expand through internal resources & capital (the six capitals mentioned earlier) 2) different capital expenditure and working capital commitments. This ratio ignores
Use of retained earnings and financing capital for investment, expansion and Weighted Avg Common Share O/S these factors. Similar to the PE ratio, the reasonable value is industry dependent
diversification. 3) May use capital investment appraisal techniques (e.g. Discounted
Cash Flow) to help assess whether project or investment creating business value
Ratio=
Current Share Price 11) Earning Before Interest, Taxes, Depreciation and Amortisation multiple (EBITDA
Earnings per Share x)
= Enterprise Multiple

BV Per Share=
Common shareholder s ' Equity ; Div = Enterprise Value / EBITDA (EV/EBITDA)
12) EV/EBITDAR= EV/(EBITDA and Rental)

CommonShares Outstanding
Mkt Cap
DPS MV/share= Lenders normally require borrower to restrict its borrowing to a limit as well as based
yield= O on interest payment coverage ratio. Therefore, the borrower may have a lot of loan on
CMP Common Shares interest payment coverage ratio. Therefore, the borrower may have a lot of loan
S covenant conditions, restricting its borrowing ability. ; Transaction costs - Such cost
exists and can become significant if frequency of trading and transactions are high
Additional requirements: Taxes on sale of capital assets such as properties and
investment ; Carry-forward tax losses? ; Discount (or Premium) on unquoted shares ;
P/B=
MKT CAP CF Per Share
5) Variability of return to the shareholders is generally much higher in levered firms,
proving that they have higher financial risk. Risk and variability is caused by the
Time left for sale of items ; Additional expenses ; Advertising and commission ; changes in the capital structure, not from operations. This implies that geared companies
Professional fees ; Redundancy and severance payments Total Common Shareholder Eq should have a higher beta as compared to the ungeared companies.

= CFO−
Pref ÷¿
2) Income Based Models (Div Disc) ¿ P/CF= 6) Hamada Equation:
Wtd . Avg . No . of shares
Gordon Growth: P0= D1/(Re-g) …… => Re= (D1/P0) + g OR Div Yield + Capital Share Price Asset Beta = Beta (U) =βU = βL
Gain Yield (Where Re is the expected return on the stock). ¿¿
CF per Share Equity Beta = Beta L = β = β ¿ (1−T )]
L U c
1) Trailing (ttm) PE: MP/EPS0 ; Leading PE: CMP/EPS1 ; Jus PE: payout ratio/ (req
D0 (1+ g s) RRoR –g) ; Subtract treasury stock from the O/S common shares in EPS formula
H Model: P 0 = V D= + D ¿ ¿ where gs= LT
0
and EV
Lecture 3 (Market-Based Approach)
r−g s
stable growth & gh means ST rate 4. LT Solvency Ratio
Normal g abnormal g
H Model only works when the declining period is not long and stable g rate is not large Total Liabilities Methods of doing market based analysis: CTM method: Suppose a company’s
NPAT is 10m and we know that other firms was sold at x of NPAT and there is a
control premium of equity, then value would be just me x*NPAT since the control
Debt ratio= ( ¿Total Debt ) D/E= premium is already included in the sale. Comparable Company Method (for majority
Problems with DDM: Suitable for min shareholders for companies with well stake): Suppose a company’s NPAT is x m and we know that other firms have a P/E of
established div policy ; Very sensitive to g due to perpetual g assumption. Temp div g
can exceed the industry g but is not suitable in LT. the div g cannot exceed profit g in
Total Assets yx and there is a control premium of a for full equity. Therefore, we would say that the
value of this part of the equity is y*x+a(y*x). Comparable Company Method (for
LT. Also, div g must be smaller than E(Rate of return) or Re.
Total Debt EBIT minority stake): Same example as above, just assume that the stake we are buying is
less than 50%, then no prem required.
ICR=
Estimating g: 1) Analyst forecast ; 2) Mgmt est ; 3) hist g ; 4) company’s fundamental Shareholders Equity ∫ exp Best use of the market approach is when the subject company has an identifiable
and prof trends ; 5) retention ratio (g= b*ROE OR g= b*ROI)(ROI is also denoted as r)
(b is based on NPAT not paid out as div OR b =(NI-Divs)/NI ; 6) g must be sustainable.
Significant change in the capital structure can affect such an assumption. Total Debt ( TD ) earnings trend and has the capability to generate earnings that can warrant a higher
value as compared to its underlying net tangible assets. For companies that are at the
Debt to Capital Ratio= infancy of its development, the market approach using revenue and net assets as the

Terminal Value estimation: 1) Constant Growth: ; 2) H Model ; 3) Market Approach:

TD+ Shareholder s ' Equity financial metrics is also commonly adopted.

Price multiple (eg PE,PB) on some economic multiple (eg EBIT, NI) at the end of
explicit forecast period. It is a mix of mkt and income approach. Mkt condition at the Equity Multiplier=
Total assets If EBITDA is negative , just use EV/Revenue or something to counter this.
end of 4/5 yrs may not be the same as today. 4) Liq Value: If company will cease
operations and liquidate its assets at the end of the explicit forecast period. Total Equity
Total debt here refers to interest-bearing debt (both ST and LT)
Lecture 5 (FCFF, FCFE, Cost of Cap, CAPM) Adjust for, one off, non-operating assets, goodwill or intangible writeoffs, income
and exp arising from non-arms length transactions, extraordinary items

5. ST Solvency Ratio
1) FCFF= EBIT(1-tax on EBIT) + NCC – Capex – Change in WC
Factors to consider: Which profit margin to use? ; Implication of dep/amort, capital
structure, size effect: use p/b, p/s or p/e? ; potential growth in revenue/profit: p/cf or
Formulas: WCT= Net Sales/Avg WC ; ITR= COGS/Avg Inv ; DOI= 365/ITR ; ART= p/s ; Comparable Products or Customer Portfolios – PEG, P/CF or P/E? ; Historical vs
Note: 1) Disc at WACC, 2) EBIT(1-t) = NOPAT, 3) FCFF is an indicator of the firm Future earnings: based on quality of forecast ; Prem or Dis embedded in the transaction
Net Cred Sale/Avg AR ; DSO= 365/ART ; APT= Credit Purch/Avg AP ; DPO= 365/AP
value. 4) Firm Value does not = Equity Value, 5) -ve values means cant cover cost and multiples ; company reputation, goodwill, etc ; valuation range and expected rates of
Current Ratio: Avg CA/Avg CL ; QR: (Avg. Cash + Avg Mkt Securities + Avg AR)/Avg
inv. returns
CL ; Cash Ratio= (Avg Cash+ Avg cash equivalents)/Avg CL ; CCC= DOI+DSO-DPO

2) FCFE= EBIT – Int – Tax + NCC – Capex – change in WC + New debt – Principal Types of earnings to be used: Business is mature: Historical and Current earnings ; No
1) IF ITR>IND AVG= means that you might be selling goods at a discount
repayment of old debt Significant changes envisaged: hist, curr and forecasted earnings ; ongoing changes in
2) IF ART s high, it is good
Note: FCFE gives the value of equity; Disc using req return on eq (Re) (same as DDM) products and services: Forecasted ; Volatility in earnings: Avg Earnings
3) IF APT is high, do not pay too high
8) Pros & Cons of FCFF: Pros: 1) All points in FCFE ; 2) easier to estimate the opr CF
(without estimating the time and value of debt inflow or outflow) ; 3) Company’s Opr
3) Common Adj to CF: Opr Profit + Dep + Restructuring Exp (Accruals) -- CF g estimate is easier to estimate than the CF to eq shareholder only. Cons: All points Weighted avg earnings: Basically rate last 5 yr’s earnings from 1 to 5. And then
Restructuring Income (which is write back of excessive accruals or prov) – Cap Gain + in FCFE. multiply the relevant earning for the one with rating ‘1’ with 1/15. Do this for all to
Cap Loss – FX Gain + FX Loss come to an avg.
^^ because 1) acc and provs are non cash , 2) cap gains and losses are just acc adj and
cash flows are alr recorded based on receipts ; 3) FX also same logic: full amt of FX is
9) FCFF vs FCFE: 1) FCFF provides firm value without debt CF ; 2) FCFF is useful in
paid or received. The translation at record date create paper P/L.
valuing firms with confusing capital structure and firms with high leverage and being in Trailing PE or EPS is used when forecasted returns cannot be estimated. Forward P/E
the process of reducing it to achieve its target capital structure. 3) Both should or NTM EPS is used when prev earnings are not reflective of the future.
theoretically provide the same value 4) Both is used to cross check 5) Disc rates are diff
4) Issues Concerning FCFE Modelling: 1) Suitable for major inv looking to control ; to show risk
2) better model than DDM when company pays no div/irregular pattern of div/irregular
div payout ratio ; 3) estimates CF from opr asset and ignores cash generated from non For Monthly EPS COMPUTATION, do 1/12*Current yr EPS + 11/12*next yr EPS
opr assets (eg marketable securities). Therefore need to separately estimate. ; 4) FCFE
can be seen as the CF available for div and therefore same g can be used as DDM ; 5) 10) Mid-Year Discounting: Discount CF1 at 0.5, CF2 as 1.5….. To do this, you can
DDM tends to provide a lower valuation number since we use proportion of the retained also.. DO FULL YEAR then multiply that number with (1+r)^(1/2)
earning. FCFE provides higher valuation.
11) Difference in Equity Value using Different Techniques (Discounted CF vs BS):
Discounting: Discounting based on operating cash flow to determine Enterprise Value. MID TERM PAPER NOTES
5) Pros of FCFE: 1) Not affected by discretionary div policy ; 2) good for valuing Also, to determine equity value, need to add back Surplus Cash (not involved in the opr
companies with no/irregular div policy ; 3) measures cash flow generating ability ; 4) CF. Balance Sheet: Equity Value from market value (if traded) or fair value (of Balance Whenever debt is mentioned, it always refers to the interest bearing debt. You would
controlling int companies ; 5) considering and incl more major assump and future sheet). Also, Enterprise Value is determined based on ALL Cash (in B/S) have to not take A/C PAYABLE, TAX PAYABLE, OTHER PAYABLES from current
expectations ; 6) no need for comparable data and easy sensti and scenario analysis liab. Bank loans, Overdrafts are included.

NOTE FOR THIS LECTURE: Equity and Debts should be valued at their respective
6) Cons of FCFE: 1) requiring major CF estimation (extra for FCFE: net borrowing) ; Market Values. If they are traded, their respective market values will be used. If they THE ABOVE IS EVEN TRUE FOR CALCULATING EV. REMOVE NON
2) possible -ve CF when yrs with high g opportunities ; 3) complex and subjective are not traded, they are assumed to be valued at fair value due to fair-value RECURRING ITEMS FROM EBITDA COMPUTATIONS.
assump which causes change in answer ; 4) disc rate diff to know accounting used.

IN D/E CALCULATIONS, use the above mentioned debt and the equity is just the BV
7) Issues Concerning FCFF Modelling: 1) Calculates EV instead of equity value. Eq 1) BETA measures the systematic risk of.a particular stock. It is sensitive to the time of equity found.
Value= EV - Debt + C&C Equi + Value of non opr assets (Calc by income, mkt or asset interval taken and different sources can give you different betas for a company. Beta is
based approach. We only estimate CF form opr assets and therefore, separately estimate dependent of 2 factors: Business and Financial Risk. Higher these risks, higher will be
value of non opr assets. 2) Estimation of reliable g. We use same as FCFE/DDM but the beta. It is also the slope of the CAPM. CHECK FOR SIZE AND LIQUIDITY PREMIUM
normally FCFF should be diff from FCFE due to presence of debt. Est g in levered firm
should be higher in FCFE than the FCFF g for the same firm as FCFF incl cash for both
eq and debtholders.
2) Market Risk Premium is forward looking expectation based, not directly INTANGIBLE LAST PART:
observable, country specific and can be calculated using historical analysis or surveys iii) With or without method: This is also called Comparative income differential
with investors. method, Income increment/cost decrement method, Comparative business valuation
method, Differential value method. Similar to the incremental cash flow method.
Comparing present value of cash flows of a business having the intangible asset with the
3) Equity Beta (also called geared beta) takes into consideration both, the business and same business without the intangible asset. Steps: i) Establish the after-tax cash flows
the financial risk. This is same as the betas of the company. generated by an entity owning the intangible asset over its economic life and discount
such cash flows (FCFF) to the valuation date using the risk-adjusted discount rate
specific to the intangible asset (i.e. With) ii) Repeat the same considering without the
4) Asset Beta (also called ungeared beta) takes into account only the business risk of the intangible. Iii) Calculate the difference between the two scenarios (the differential
company or finds what the risk would be if company was fully financed with debt. value) iv) Apply a probability factor, if any, for the estimation of the possibility and
likelihood of the without scenario to the differential value v) Add TAB, if any

5) We also add a Size Premium or a Liquidity Premium to the normal CAPM. The
premium usually applies to forward-looking expected return only.

6) Alpha Value: There can be gap between the return of the stock and the return that we
got from the CAPM. This is mainly due to the unsystematic risk associated with the
stock. Over a long period of time, the alpha value should be equal to zero. Well-
diversified also 0.

7) Perpetual Cost of debt formula: (Coupon/CMP)*(1-t). For other cost of debt

computations, if no interest rates given, calculate the bond’s YTM using the financial
calculator.

8) Irredeemable preference share cost: (Div/CMP). REMEMBER NO TAX

REDUCTION.

Lecture 6 (MM Theorem and Hamada Equation)

1) MM1 (Without Taxes): Debt is risk-free and is freely available at the same cost as to
the equity investors. Therefore, capital structure is irrelevant and has no impact on the
wacc. In this case, the MV is determined by total earnings of the company and the level
of business risk of the company. NO financial risk. Proposition 1 states that the value of
a levered is same as the levered. Therefore, Vu=Vl. Proposition 2 says that the cost of

D . And WACC of the firm=

equity (Re) = r e = r 0 + (r 0 - r d )
E

[ ][ ]
D E
r + r
V d V e
remains same.
. In MM1, the Re increases but the Rd and WACC

2) MM2 (Without Transaction cost): In this, Rd remains the same but is lower due to
the tax benefit that the companies would get. The WACC reduces due to the tax benefit
and companies should borrow as much as possible till their Wd is next to a 100%. The
Re keeps rising in this case too. Proposition 1 states that the Vl= Vu + D*tax rate..

D (1-t).
Proposition 2 says that the cost of equity (Re) = r e = r 0 + (r 0 - r d )
E
And WACC of the firm=
[ D
V
E
r d (1−t ) + r e
V ][ ] OR r WACC L
 D
= r 0 ¿) ¿ r 0 ¿ T ¿.
V c
3) Weakness of MM: MM assumes that inv have the same info, react rationally and
borrow and lend at the Rf rate. It assumes that the prices reflect all info and no trans
cost.
4) In reality, Debt Capacity - Company has a borrowing limit mostly based on its
ability to provide collateral on the debt and its certainty in generating earnings and cash
flow. ; Asymmetric Information - Lenders may not provide the loans due to
reservation on assumptions and uncertainty on borrower’s ability to delivery the results
and repayments. It may be in the borrower’s interest not to provide full picture to the
lenders if it has problems to delivery the results. Share price may not reveal all
information about the company. ; Pecking order - Management may place higher
priority to funding sources that reveal the least amount of information. ; Cost of debt -
Cost of debt increases when more risk associates with the borrower as the lender would
require higher rate of return to justify the risk. ; Tax Benefits - If the borrower
continuous to borrow, its interest payments may eventually exhaust all profits turn into a
loss-making company which cannot utilise the tax benefit. ; Loan Covenants -