Valuation of Firms Lecture Notes

These flashcards cover key concepts, definitions, and frameworks discussed in the Valuation of Firms lecture notes.

What is valuation?

Valuation is the estimation of an asset’s value based either on variables related to future investment returns or on comparisons with similar assets.

Why is firm value important?

Firm value is crucial for investment decision-making, corporate performance evaluation, measuring investor confidence, assessing financial health, and more.

What is the purpose of portfolio management in the context of valuation?

Portfolio management considers asset valuation as part of a broader investment strategy, focusing on risk-adjusted returns and diversification.

What are key considerations in asset valuation?

Risk-adjusted returns, correlation with other assets, overall portfolio risk, and liquidity considerations.

What are the steps in the valuation process?

1. Understanding the business 2. Forecasting performance 3. Selecting valuation model 4. Valuating the firm 5. Making investment decisions 6. Writing a research report.

What factors should be analyzed to understand a business?

Industry trends, regulations, competitive landscape, and macroeconomic factors.

What are some common valuation models?

Balance sheet models, absolute valuation models, cash flow models, and relative valuation models.

When is the Dividend Discount Model (DDM) appropriate?

When a company consistently pays dividends that align with its profitability and it has a stable dividend policy.

What is the main takeaway regarding choosing between FCFE and FCFF?

Use FCFE for stable capital structures and FCFF when leverage is high or changing.

What does Residual Income represent?

Residual income is the income a firm generates after accounting for its true cost of capital.

What is Economic Value Added (EVA)?

EVA is a commercial implementation of residual income, representing the true economic profit of a company.

How do you calculate Market Value Added (MVA)?

MVA = Market Capitalization - Book Value of Capital.

What is the Cash Flow Return on Investment (CFROI)?

CFROI measures the average economic return on all of a company's investment projects in a given year.

What is a significant disadvantage of traditional earnings measures?

Traditional earnings measures can either double-count or ignore certain cash flows, leading to valuation inconsistencies.

What is the importance of writing research reports in valuation?

Research reports are crucial for communicating analysis, forecasts, and investment recommendations to stakeholders.

What should be considered in valuation under uncertainty?

Sensitivity analysis is used to assess how variable estimates like free cash flow and risk factors affect valuation.

What is the significance of the chosen discount rate in valuations?

The discount rate reflects the time value of money and risk, impacting the perceived value of future cash flows.