# Finance exam outline

**Topics:**Stock market, Discounted cash flow, Fundamental analysis

**Pages:**10 (1483 words)

**Published:**January 26, 2014

Course review

Ale Previtero

AGENDA

1. Overview of valuation cases

2. WACC

• Cost of equity, choosing beta, choosing weights, when to

use premium.

3. Valuation using Discounted Cash Flow (DCF)

• Key assumptions, Terminal Value, sensitivity

4. Valuation using multiples

• Key points, pros & cons, choosing comparable firms

• Which multiple? Which year? Example.

5. Financing an Acquisition

• Determine price. Financing. Making a decision.

6. Final exam

• How to review, how to approach the case

1. OVERVIEW OF VALUATION CASES

CASE (Protagonist)

DESCRIPTION

WHAT DID WE DO?

1. OXFORD LEARNING

(Nick Whitehead, CEO)

Founder decision to sell

equity in a private firm

DCF + valuation using

multiples

2. CROCS

(Stacy Yeung, analyst)

Investor decision to buy,

hold, or sell shares

DCF + valuation using

multiples

3. ROSETTA STONE

(Tom Adams, CEO)

CEO decision on price to DCF + valuation using

sell shares in IPO

multiples

4. MERCURY ATHLETIC

(John Liedtke, Active Gear

Inc.)

Bidder price to acquire a

division of a company

DCF + valuation using

multiples

5. EMPIRE

(Greg & Scott, Scotia

Capital)

Bidder price to acquire a

publicly-traded company

(Oshawa)

DCF of stand-alone firm +

synergies, valuation using

multiples, bidding strategy

+ financing

2. WACC – CHOOSING WEIGHTS

Since we are discount future FCFs, we want a forwardlooking WACC Hence we want to use forward-looking capital structure:

1. Use the company target capital structure

– As stated by the management (case fact)

– As from comparable firms (if the case facts hint you so) 2. Use actual capital structure based on market weights

– It is ok to use the book value of interest-bearing financial debt

– Avoid book value of equity (it’s a plug)

2. WACC – COST OF EQUITY (CAPM)

Risk-free rate:

– Use longest maturity riskless rate available

– 20/ 30 years T-bonds

Beta: measure of a firm’s sensitivity to systematic risk (a share’s relative variability è covariation of stock returns with overall market returns)

– Estimated by regressing stock returns on market returns Market risk premium (MRP): expected premium for holding

stocks over riskless bonds (historically around 5%)

2. WACC - CHOOSING BETA

If the share is traded, use its actual beta

– If you assume a new target capital structure for your valuation, unlever and relever the firm’s beta based on your target capital structure

If the share is not traded, follow these steps to determine

its hypothetical beta:

1. Get levered betas (called also equity betas) betas for as many industry comparables as are available

2. Drop any obvious outliers

– If a company is not an obvious outlier, better to keep it 3. Calculate the average of the levered beta for the remaining firms 4. Unlever the average beta using the average of the actual debt / equity ratio (using market weights) to obtain the average unlevered beta (called also asset beta)

5. Re-lever this industry average unlevered beta using the firm’s target capital structure to get its levered beta

3. VALUATION USING DCF - ASSUMPTIONS

Key questions:

• What are the industry key success factors?

• What is the competitive environment?

• Where is the firm in its life cycle (growth, mature, decline)? • What are the firm’s value drivers?

è All these points come from the SIZE-UP

Answers to these questions will drive assumptions:

• Sales growth rate + perpetuity growth

• EBITDA margin

• CAPEX and depreciation (Net Fixed Assets / Net PP&E)

• Working capital

3. VALUATION USING DCF – TERMINAL VALUE

Terminal value = enterprise value at some point in future

– Key assumption: the firm is expected to be mature at the end of the projection period in 5 (or 10) years

We use the constant growth DDM model (applied to

FCFF) to get TV

– Check how important is the TV (discounted to today) for your EV calculation è >75% is...

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