# M7.1 Challenging the Market Price: Cisco Systems, Inc.

Size: px
Start display at page:

## Transcription

1 M7.1 Challenging the Market Price: Cisco Systems, Inc. Price = \$24 per share Forward P/E = \$24/\$1.42 = 16.9 Book value per share = \$6.68 P/B = \$24/6.68 = 3.59 B/P = Introduction Part A of this case asks you to challenge the market price of \$24 or, alternatively stated, to challenge the market s P/B ratio of As a P/B ratio is based of expected residual earnings, this comes down to asking whether the P/B ratio is justified on the basis of residual earnings forecasts. Given that we have only two years of analysts forecasts, we do not have the complete set of forecasts to challenge the \$24 price. Of course, we might develop a full analysis to do this (as will be done in Chapters 8 16), but for now we are asked to challenge the price with the limited forecasts. Reverse engineering gives us the handle. This is done by asking two questions that correspond to parts A and B of the case: A. What are the forecasts implicit in the market price, and are these reasonable? This is done in three steps: 1. Calculate the implied residual earnings growth rate after 2011 that is implicit in the market price. 2. Translate the residual earnings growth rate into an EPS growth rate 3. Ask whether, given our knowledge of Cisco and its operations, the implied EPS growth rates are reasonable. B. What is the expected return to buying Cisco at \$24, and is this good enough? Before beginning the case, it is helpful to remind ourselves of the principles of fundamental analysis: 1. Don t mix what you know with speculation 2. Anchor a valuation of what you know 3. Beware of paying too much for growth The Questions

2 Part A The challenge to the market price is a challenge to the market s growth forecasts. To challenge those, we anchor on book value (which we know) and short-term forecasts (about which we are reasonably confident). To begin, establish the no-growth valuation based on these inputs. Separating value with no growth from value from speculative growth To proceed, one needs a required return. This is the investor s choice his or her hurdle rate. We will use a 10% rate here, but the analysis can be tested for sensitivity to this rate, made easier if the analysis is put into a spreadsheet. The pro forma to challenge the price is as follows. This pro forma identifies the no-growth value of \$14.63 per share: 2009A 2010E 2011E EPS DPS BPS Book rate of return 21.3% 19.9% Residual earnings (10% charge) Growth in residual earnings 6.38% Growth in EPS 13.4% Value of Equity 0 ( ROCE1 r) B0 ( ROCE2 r) B1 B0 Value of Speculative Growth 1 r (1 r) r \$ 6.68 Value of Speculativ e Growth = \$ Value of Speculative Growth = \$ Value of Speculative Growth As the stock is trading at \$24, we have the value that the market is placing on speculative growth: \$ = \$9.37. The market is asking us to pay \$9.37 for growth. Do we want to pay this much? We now have the components of a building-block diagram like that in Figure 7.4:

3 Block (1), book value, we know for sure; block (2) we know with some certainty (let s say) it s been subject to analysis based on considerable information but block 3 is where we are most uncertain. This block is what we have to challenge. We do so by eliciting the market s growth forecast. Reverse engineering the market s growth forecast This is accomplished by solving for g in the residual earnings valuation model: Value of Equity0 \$24 \$ (1.10 g) The solution for g = , or a 5.63% growth rate. So the market is forecasting that RE will grow at a 5.63% rate every year after Is that a reasonable forecast? Rather than applying a valuation model to transform one s own forecast to a value, we have applied the model in reverse engineering mode to extract the market s forecast. This is the way to handle valuation models. By resisting the temptation to plug a speculative growth rate into a model, we have heeded Graham s warning (in the chapter) about formulas out of higher mathematics, particularly the growth rate in those formulas. Rather, we have turned the model around as a tool to challenge the market speculation about growth of which he was so skeptical. The growth rate is the residual earnings growth rate, a little difficult to get our minds around. But we can convert this growth rate to an EPS growth rate by reverse engineering the residual earnings calculation:

4 As Residual Earnings t+1 = Earnings t+1 (r Book value t ), then Earnings t+1 = (Book value t r) + Residual Earnings t+1. Cisco s residual earnings two years-ahead (2011) is \$0.800 per share, so the residual earnings forecasted for the third year ahead (2012) at a growth rate of 5.63 percent is \$ Thus, with a per-share book value of \$9.71 forecasted for the end of 2011, the implicit forecast of EPS for 2012 is EPS 2012 = \$( ) = \$1.816 and the forecasted growth rate over the 2011 EPS of \$1.61 is 12.8 percent. Similarly, the EPS for 2013 is forecast as follows: RE 2013 = RE 2012 g = = BPS 2012 = BPS EPS 2012 DPS 2013 = = EPS 2013 = ( ) = The forecasted EPS growth rate for 2013 = 2.046/1,816 1 = 12.6%. Extrapolating in the same way to subsequent years, one develops the earnings growth path that the market is forecasting, displayed below:

5 If the analyst forecasts growth rates above the path implied by the market, she would say that Cisco was underpriced at \$24. If the analyst forecasts growth rates below the path implied by the market, she would say that Cisco was overpriced at \$24. The path separates the BUY and SELL regions. To be confident in her assessment, she would model the EPS path, using the full financial statement analysis and pro forma analysis that we will move on to in Chapters Those chapters provide the analysis to get a better handle on growth. In the absence of that analysis, the analyst can look at growth up to the forecast horizon as an indication of the firm s ability to deliver subsequent growth. The residual earnings growth rate forecasted for Cisco in 2011 is 6.4 percent in the pro forma above, contrasting with the longterm rate of 5.63 percent inferred from the market price. For speculation, she may then turn to softer inputs than the accounting. She understands, first and foremost, that a good knowledge of the business is prerequisite for grappling with the issue. She understands that exceptionally high growth rates are not likely to eventuate unless the firm has a strong sustainable competitive advantage. She understands that technological advantage can be eroded away. She is reminded that the implied residual earnings growth rate of 9.3 percent in the \$77 price for Cisco in 2000 looked absurd to anyone who understood business, and proved to be so. She dissented from technology analysts of the time who advised buy Cisco at any price. While remaining skeptical of prices, the investor also maintains respect. She understands that she cannot be the sole possessor of knowledge and is wary of the dangers of self-deception and overconfidence. So she allows the market price to challenge her: What do others know that I do not know? Is the market speculating about a takeover? Am I missing something? Or is it the case that I cannot justify the growth expectations in the market price? The game is against other investors and the consensus view is to be acknowledged and understood. She may conclude that animal spirits are moving the crowd (and prices), but may also conclude that there are rational

7 -2% 4.49% -1% 5.18% No-Growth: 0% 5.91% 1% 6.64% 2% 7.37% 4% 8.83% 6% 10.30% 8% 11.76% One can run thought experiments with this profile. If you (as a conservative investor) refuse to pay for any growth, you ll get 5.91%, and if you will not pay for more than 4% growth, you ll get 8.83%. But the profile also gives the upside and downside. You may be conservative and be satisfied with a return of 5.91% with no growth, but the profile tells you there is also some prospect you ll do better than that if growth materializes. And it also gives the downside: the lower returns for negative growth indicate how much you can be damaged. To complete your investment decision making, you will need to get a feel for the probabilities of achieving the different growth outcomes. That can only be down with further analysis, with which much of the rest of the book is concerned. Growth and Risk: Turning it Around One can ask what is the expected return for different growth rates, as we have just done. But one can also ask what is the market s forecast of growth for a different required return. Suppose we set the required return = 12%. Then the reverse engineering exercise in Part A is based on the following pro forma: The pro forma 2009A 2010E 2011E EPS DPS BPS Book rate of return 21.3% 19.9% Residual earnings (12% charge) Reverse engineering from the market price of \$24 to the growth rate:

8 Value of Equity 0 \$24 \$ (1.12 g) The solution: g = (an 8.6% growth rate) The forecast of EPS growth for 2012 = 15.4% (following the procedures to get from the RE growth rate to the EPS growth rate. You will note that both the implied RE growth rate and the EPS growth rate are higher than that for a required return of 10%. You require more growth to buy at \$24 if your required return is 12% This is growth and risk in action: More risk (and a higher required return), you require higher earnings growth to cover your risk. Handling the Required Return: the Margin of Safety We do not know the required return, but here is a way to handle it. Put in a required return that is higher than your hurdle rate you are building in a margin of safety. If, at the current market price, you see reasonable or achievable growth (that you can justify), then you are buying it with a margin of safety. Part D The lesson from Cisco s decline in price from \$71 in early 2000 to \$15 by August 2011: Growth that was priced in at \$71 (and a P/E of 130) can disappear. Growth gets competed away, even for a great company like Cisco of earlier years. Growth is challenged by competition and technological change. Few firms have durable competitive advantage. Buying growth is risky, so require a higher return. A Modification for Estimating the Implied Growth Path from the Market Price The implied RE growth rate with a required return on 10% in Part A of the case was 5.63%. That is the RE growth rate forecasted for 2012 to the very long term. However, it might be the case that, rather than forecasting a constant growth rate, we might see growth at a higher level in the near term, declining to a lower rate in the long term (as competition sets in and the firm becomes more like the average firm). Indeed, we see in the pro forma that Cisco is projected (by analysts) to have a 6.36% growth rate in 2011.

9 A reasonable forecast of growth is the very long term is the GDP growth rate the average rate for the economy and all firms in the economy. To capture the gradual decline to this rate, we can apply weights to the 2011 growth rate for Cisco (6.38%) and the 4% long-term rate, with weights than add to 1.0. If those weights are (0.8, 0.2), then Growth rate for 2012 = ( %) + ( %) = 5.90% (and so on, recursively for years after 2012). The 2012 growth rate iss lower than the 6.38 percent for 2011 because it is on a path to decline to 4 percent inn the long run. Applying the weights to subsequent years, the forecasted growth rate for 2013 is 5.53 percent, declining to 4 percent eventually, and 4.4 percent within 10 years. So we establish a fade rate for growth. This path yieldss a valuation of \$ The path is plotted below and compared to a path with weights of (0.9, 0.1). The (0.9, 0.1) weighting sees the growth rate nearing 4 percent considerably further inn the future, reaching 4.44 percent in 20 years, and yields a valuation of \$ As before, these residual earnings growth paths can be converted to EPS growth paths, as above. While the weights are somewhat arbitrary, they focus our thinking: How long do I expect Cisco to maintain a growth rate superior to the economy as a whole?

10 One can also turn the exercise around to challenge the market price: rather than inferring one long-term growth rate from the market price, as before, infer the weights that the market is applying to forecast the decline in growth rates from the short-term rate of 6.38 percent to the long-term anchor of 4 percent. The weights that yield the market price of \$24 are (0.98, 0.02), indicating that the market expects reversion of the growth rate to 4 percent far in the distant future, indeed reaching 4.4 percent 100 years hence. This growth path is also plotted in figure above. Is this growth path a reasonable one given one s knowledge of the company? See Penman, Accounting for Value, Chapter 3 for more.

### M5.1 Forecasting from Traded Price-to-Book Ratios: Cisco Systems Inc.

M5.1 Forecasting from Traded Price-to-Book Ratios: Cisco Systems Inc. Price = \$21 Required equity return = 12% Forward P/E = \$21/\$0.89 = 23.60 Book value per share = \$25,826/6,735 = \$3.835 P/B = \$21/3.835

### Accrual Accounting and Valuation: Pricing Earnings

Security, Third Chapter Six LINKS Accrual Accounting and : Pricing Earnings Link to previous chapter Chapter 5 showed how to price book values in the balance sheet and calculate intrinsic price-to-book

### CHAPTER FOURTEEN. Simple Forecasting and Simple Valuation

CHAPTER FOURTEEN Simple Forecasting and Simple Valuation Concept Questions C14.1 Book values give a good forecast when they are reviewed at their fair value: applying the required return to book value

### CHAPTER FOUR Cash Accounting, Accrual Accounting, and Discounted Cash Flow Valuation

CHAPTER FOUR Cash Accounting, Accrual Accounting, and Discounted Cash Flow Valuation Concept Questions C4.1. There are difficulties in comparing multiples of earnings and book values - the old techniques

### Risk Aversion. Expected value as a criterion for making decisions makes sense provided that C H A P T E R 2. 2.1 Risk Attitude

C H A P T E R 2 Risk Aversion Expected value as a criterion for making decisions makes sense provided that the stakes at risk in the decision are small enough to \play the long run averages." The range

### SHORT INTRODUCTION OF SHORT SELLING

Financial Assets and Investing SHORT INTRODUCTION OF SHORT SELLING Dagmar Linnertová Faculty of Economics and Administration, Masaryk University, Lipová 41a, 602 00 Brno, e-mail: Dagmar.Linnertova@mail.muni.cz

### FNCE 301, Financial Management H Guy Williams, 2006

Stock Valuation Stock characteristics Stocks are the other major traded security (stocks & bonds). Options are another traded security but not as big as these two. - Ownership Stockholders are the owner

### THE VALUATION OF A SAVINGS ACCOUNT

THE VALUATION OF A SAVINGS ACCOUNT (With Seven Insights) A savings account is a simple investment that we all understand. We shall use it as a prototype for equity valuation. We shall use it to test ideas

### Knowledge Series : P/E Multiple. January 2009

Knowledge Series : P/E Multiple January 2009 Introduction to the P/E Multiple - The P/ E Multiple (or Ratio) is one of the most common indicators to judge the worth of a company s shares - Most people

Review for Exam Instructions: Please read carefully The exam will have 1 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation questions.

### Primary Market - Place where the sale of new stock first occurs. Initial Public Offering (IPO) - First offering of stock to the general public.

Stock Valuation Primary Market - Place where the sale of new stock first occurs. Initial Public Offering (IPO) - First offering of stock to the general public. Seasoned Issue - Sale of new shares by a

### Investing on hope? Small Cap and Growth Investing!

Investing on hope? Small Cap and Growth Investing! Aswath Damodaran Aswath Damodaran! 1! Who is a growth investor?! The Conventional definition: An investor who buys high price earnings ratio stocks or

### In line performance. Results update 4Q2015. Banks UAE 28 January 2016 DUBAI ISLAMIC BANK

28 Jan 15 28 Apr 15 28 Jul 15 28 Oct 15 DUBAI ISLAMIC BANK In line performance Results update 4Q2015 Banks UAE 28 January 2016 Dubai Islamic Bank s (DIB) reported net profit of AED865mn, in-line with our

### Lecture Notes 11. Equity Valuation. VI. DDM, Investment Opportunities, and Payout Policy

Prof. Alex Shapiro Lecture Notes Equity aluation I. Readings and Suggested Practice Problems II. aluation and its Uses III. Present alue Models I. Approaches to Expected Return etermination. Constant Growth

### CHAPTER 11: THE EFFICIENT MARKET HYPOTHESIS

CHAPTER 11: THE EFFICIENT MARKET HYPOTHESIS PROBLEM SETS 1. The correlation coefficient between stock returns for two non-overlapping periods should be zero. If not, one could use returns from one period

### Chapter Seven STOCK SELECTION

Chapter Seven STOCK SELECTION 1. Introduction The purpose of Part Two is to examine the patterns of each of the main Dow Jones sectors and establish relationships between the relative strength line of

### CHAPTER 21: OPTION VALUATION

CHAPTER 21: OPTION VALUATION PROBLEM SETS 1. The value of a put option also increases with the volatility of the stock. We see this from the put-call parity theorem as follows: P = C S + PV(X) + PV(Dividends)

### CHAPTER FIFTEEN. Full-Information Forecasting, Valuation, and Business Strategy Analysis

CHAPTER FIFTEEN Full-Information Forecasting, Valuation, and Business Strategy Analysis Concept Questions C15.1 To forecast future financial statements, the analyst must know where the business is going.

### Nature and Purpose of the Valuation of Business and Financial Assets

G. BUSINESS VALUATIONS 1. Nature and Purpose of the Valuation of Business and Financial Assets 2. Models for the Valuation of Shares 3. The Valuation of Debt and Other Financial Assets 4. Efficient Market

### Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Chapter 8 Capital Budgeting Concept Check 8.1 1. What is the difference between independent and mutually

TRADING EDUCATORS WELCOMES YOU TO OUR TRADERS UNIVERSITY PREREQUISITE FOR THIS MATERIAL The prerequisite for this material is having studied The Law of Charts. Study it thoroughly. You must know about

### Setting the scene. by Stephen McCabe, Commonwealth Bank of Australia

Establishing risk and reward within FX hedging strategies by Stephen McCabe, Commonwealth Bank of Australia Almost all Australian corporate entities have exposure to Foreign Exchange (FX) markets. Typically

### Company Fundamentals. THE CMC Markets Trading Smart Series

Company Fundamentals THE CMC Markets Trading Smart Series How to evaluate company growth potential At any given point in time, share prices tend to represent the sum of expectations about its value from

### Equity Analysis and Capital Structure. A New Venture s Perspective

Equity Analysis and Capital Structure A New Venture s Perspective 1 Venture s Capital Structure ASSETS Short- term Assets Cash A/R Inventories Long- term Assets Plant and Equipment Intellectual Property

### CENTRE FOR INVESTMENT EDUCATION AND LEARNING. Author 1 & Author 2. Location - Date

CENTRE FOR INVESTMENT EDUCATION AND LEARNING Equity Valuation and Analysis Author 1 & Author 2 Location - Date Basic Approaches to Valuation Price of an equity share in secondary market is dynamic Investors

### Chapter 8. Stock Valuation Process. Stock Valuation

Stock Valuation Process Chapter 8 Stock Valuation: Investors use risk and return concept to determine the worth of a security. In the valuation process: The intrinsic value of any investment equals the

### Chapter 4 Common Stocks

Chapter 4 Common Stocks Road Map Part A Introduction to finance. Part B Valuation of assets, given discount rates. Fixed-Income securities. Stocks. Real asset (capital budgeting). Part C Determination

### Opening Terminal Value s Black Box

Opening Terminal Value s Black Box Francisco J. López Lubian, IE Business School ABSTRACT When evaluating a company using the discounted cash flow method, terminal value can be a key factor that might

### Real estate: The impact of rising interest rates

Fall 015 TIAA-CREF Asset Management Real estate: The impact of rising interest rates Overview TIAA-CREF Global Real Estate Strategy & Research Martha Peyton, Ph.D. Managing Director Edward F. Pierzak,

### Insurers Annuity Providers

Sector Reuters reported that the Enhanced Annuity Market made up 28% of the market in Q4 2013 up from 2% in 2002. Yesterday s announcement from the Chancellor detailed radical changes to pension provision

### 20 Dividend Growth Stocks To Buy Today For Your Retirement Portfolios: Part 1

20 Dividend Growth Stocks To Buy Today For Your Retirement Portfolios: Part 1 August 7, 2015 by Chuck Carnevale of F.A.S.T. Graphs Introduction We are in the seventh year of a strong bull market, and stock

### FINANCIAL STATEMENT ANALYSIS AND VALUATION. Fall, 2013

PROFESSOR NAME: Stephen Penman Professor Office Location: 612 Uris Hall Office Phone: 212 854 9151 E-mail: shp38@columbia.edu Office Hours: Tuesdays, 3:30pm 5:00pm TEACHING ASSISTANTS TA: Hyung Il Oh hoh14@gsb.columbia.edu

### Utilizing Utilities in Shareholder Yield

MARCH 215 Utilizing Utilities in Shareholder Yield FROM THE EPOCH SHAREHOLDER YIELD TEAM Utilities stocks have historically fit the profile of shareholder yield companies and have remained a significant

### Employee Options, Restricted Stock and Value. Aswath Damodaran 1

Employee Options, Restricted Stock and Value 1 Basic Proposition on Options Any options issued by a firm, whether to management or employees or to investors (convertibles and warrants) create claims on

### Risk, Return and Market Efficiency

Risk, Return and Market Efficiency For 9.220, Term 1, 2002/03 02_Lecture16.ppt Student Version Outline 1. Introduction 2. Types of Efficiency 3. Informational Efficiency 4. Forms of Informational Efficiency

### Section 1. Introduction to Option Trading

Section 1. Introduction to Option Trading Trading stock options is a much different game from trading the underlying stocks. When options are traded for appreciation, it is a game of leverage, with big

Two-State Options John Norstad j-norstad@northwestern.edu http://www.norstad.org January 12, 1999 Updated: November 3, 2011 Abstract How options are priced when the underlying asset has only two possible

### Understanding Options: Calls and Puts

2 Understanding Options: Calls and Puts Important: in their simplest forms, options trades sound like, and are, very high risk investments. If reading about options makes you think they are too risky for

### ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure

ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure Chapter 9 Valuation Questions and Problems 1. You are considering purchasing shares of DeltaCad Inc. for \$40/share. Your analysis of the company

### Option Values. Option Valuation. Call Option Value before Expiration. Determinants of Call Option Values

Option Values Option Valuation Intrinsic value profit that could be made if the option was immediately exercised Call: stock price exercise price : S T X i i k i X S Put: exercise price stock price : X

### SPIN Selling SITUATION PROBLEM IMPLICATION NEED-PAYOFF By Neil Rackham

SITUATION PROBLEM IMPLICATION NEED-PAYOFF By Neil Rackham 1. Sales Behavior and Sales Success Small Sales Selling Techniques The traditional selling techniques that most of us have been trained to use

### multiples are easy to use and intuitive, they are also easy to misuse. Consequently, a

1 RELATIVE VALUATION CHAPTER 8 In discounted cash flow valuation, the objective is to find the value of assets, given their cash flow, growth and risk characteristics. In relative valuation, the objective

### 1 Scope and Objectives of Financial Management

1 Scope and Objectives of Financial Management BASIC CONCEPTS 1. Definition of Financial Management Financial management comprises the forecasting, planning, organizing, directing, co-ordinating and controlling

### Session X: Lecturer: Dr. Jose Olmo. Module: Economics of Financial Markets. MSc. Financial Economics. Department of Economics, City University, London

Session X: Options: Hedging, Insurance and Trading Strategies Lecturer: Dr. Jose Olmo Module: Economics of Financial Markets MSc. Financial Economics Department of Economics, City University, London Option

### P r. Notes on the Intrinsic Valuation Models and B-K-M Chapter 18. Roger Craine 9/2005. Overview on Intrinsic Asset Valuation

Notes on the Intrinsic Valuation Models and B-K-M Chapter 8 Roger Craine 9/5 Overview on Intrinsic Asset Valuation An asset is a promise to a stream of future payoffs. Unlike a commodity that you consume,

### Financial Ratio Cheatsheet MyAccountingCourse.com PDF

Financial Ratio Cheatsheet MyAccountingCourse.com PDF Table of contents Liquidity Ratios Solvency Ratios Efficiency Ratios Profitability Ratios Market Prospect Ratios Coverage Ratios CPA Exam Ratios to

### Interpretation of Financial Statements

Interpretation of Financial Statements Author Noel O Brien, Formation 2 Accounting Framework Examiner. An important component of most introductory financial accounting programmes is the analysis and interpretation

### FINANCIAL ANALYSIS GUIDE

MAN 4720 POLICY ANALYSIS AND FORMULATION FINANCIAL ANALYSIS GUIDE Revised -August 22, 2010 FINANCIAL ANALYSIS USING STRATEGIC PROFIT MODEL RATIOS Introduction Your policy course integrates information

### Terminology and Scripts: what you say will make a difference in your success

Terminology and Scripts: what you say will make a difference in your success Terminology Matters! Here are just three simple terminology suggestions which can help you enhance your ability to make your

### CHAPTER 21: OPTION VALUATION

CHAPTER 21: OPTION VALUATION 1. Put values also must increase as the volatility of the underlying stock increases. We see this from the parity relation as follows: P = C + PV(X) S 0 + PV(Dividends). Given

### Aksa Enerji Outperform (Maintained)

01.14 03.14 05.14 07.14 09.14 11.14 01.15 03.15 05.15 May 26, 2015 Outperform (Maintained) Turkey - Equity - Company Update On the verge of a new era s commissioning of the Company s first lignite power

### BEPS ACTIONS 8-10. Revised Guidance on Profit Splits

BEPS ACTIONS 8-10 Revised Guidance on Profit Splits DISCUSSION DRAFT ON THE REVISED GUIDANCE ON PROFIT SPLITS 4 July 2016 Public comments are invited on this discussion draft which deals with the clarification

### Financial Planning and Growth. Background

Financial Planning and Growth (Text reference: Chapter 26) background detailed examples factors affecting growth AFM 271 - Financial Planning and Growth Slide 1 Background financial planning may be thought

### ANSWERS TO END-OF-CHAPTER PROBLEMS WITHOUT ASTERISKS

Part III Answers to End-of-Chapter Problems 97 CHAPTER 1 ANSWERS TO END-OF-CHAPTER PROBLEMS WITHOUT ASTERISKS Why Study Money, Banking, and Financial Markets? 7. The basic activity of banks is to accept

### Additional information AQR & Stress Test October 26, 2014

LOCAL EXPERTISE MEETS GLOBAL EXCELLENCE Additional information AQR & Stress Test October 26, 2014 Comprehensive assessment: AQR and Stress Test Definitions The comprehensive assessment is a financial health

### Three Investment Risks

Three Investment Risks Just ask yourself, which of the following risks is the most important risk to you. Then, which order would you place them in terms of importance. A. A significant and prolonged fall

### Investment valuations in private equity buyouts

By Brian Gallagher, Twin Bridge Capital Partners 11 Introduction Buyout investment math (or mathematics) is the means by which investment sponsors formally analyse the assumptions they make about the past

### Running head: THE VALUATION OF WAL-MART 1

Running head: THE VALUATION OF WAL-MART 1 The Valuation of Wal-Mart CPT Becky Lux, CPT Ino Ruiz, and ENS Jujuane Hairston Army-Baylor MHA/MBA Graduate Program THE VALUATION OF WAL-MART 2 In fiscal year

### Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Chapter 3 Interpreting Financial Ratios Concept Check 3.1 1. What are the different motivations that

### Time Value of Money. 2014 Level I Quantitative Methods. IFT Notes for the CFA exam

Time Value of Money 2014 Level I Quantitative Methods IFT Notes for the CFA exam Contents 1. Introduction...2 2. Interest Rates: Interpretation...2 3. The Future Value of a Single Cash Flow...4 4. The

### Playing with Numbers

PLAYING WITH NUMBERS 249 Playing with Numbers CHAPTER 16 16.1 Introduction You have studied various types of numbers such as natural numbers, whole numbers, integers and rational numbers. You have also

TITLE: AN EXAMINATION OF THE EQUITY RISK PREMIUM ASSUMED BY CANADIAN PENSION PLAN SPONSORS Authored by: Andrews, Doug, MBA, FCIA, FSA, CFA Vice President Aon Consulting 145 Wellington Street West Suite

### FAIR VALUE ACCOUNTING: VISIONARY THINKING OR OXYMORON? Aswath Damodaran

FAIR VALUE ACCOUNTING: VISIONARY THINKING OR OXYMORON? Aswath Damodaran Three big questions about fair value accounting Why fair value accounting? What is fair value? What are the first principles that

### GESTÃO FINANCEIRA II PROBLEM SET 2 - SOLUTIONS

GESTÃO FINANCEIRA II PROBLEM SET - SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 010-011 Yield to Maturity Chapter 8 Valuing Bonds 8-3. The following

### VALUATION: MARKET-BASED APPROACHES. Learning Objectives

Chapter 13 VALUATION: MARKET-BASED APPROACHES Learning Objectives 1. Understand the practical advantages and disadvantages of using market multiples in valuation. 2. Apply a version of the residual income

### Using simulation to calculate the NPV of a project

Using simulation to calculate the NPV of a project Marius Holtan Onward Inc. 5/31/2002 Monte Carlo simulation is fast becoming the technology of choice for evaluating and analyzing assets, be it pure financial

### Gundlach The Scariest Indicator in the World

Gundlach The Scariest Indicator in the World November 19, 2015 by Robert Huebscher Those Federal Reserve governors who intend to vote for an increase in rates at their December meeting need to take a close

### Course Outline. BUSN 6020/1-3 Corporate Finance (3,0,0)

Course Outline Department of Accounting and Finance School of Business and Economics BUSN 6020/1-3 Corporate Finance (3,0,0) Calendar Description Students acquire the knowledge and skills required to effectively

### Key Concepts and Skills Chapter 8 Stock Valuation

Key Concepts and Skills Chapter 8 Stock Valuation Konan Chan Financial Management, Spring 2016 Understand how stock prices depend on future dividends and dividend growth Be able to compute stock prices

### Chapter 9 Valuing Stocks

Chapter 9 Valuing Stocks 9-1. Assume Evco, Inc., has a current price of \$50 and will pay a \$2 dividend in one year, and its equity cost of capital is 15%. What price must you expect it to sell for right

### Factors Influencing Price/Earnings Multiple

Learning Objectives Foundation of Research Forecasting Methods Factors Influencing Price/Earnings Multiple Passive & Active Asset Management Investment in Foreign Markets Introduction In the investment

### Section 9 Firm valuation: Price multiples

Section 9 Firm valuation: Price multiples A little inaccurancy sometimes saves tons of explanation. --H.H. Munro 1 Learning objectives After studying this chapter, you will understand How to use price

### Choice of Discount Rate

Choice of Discount Rate Discussion Plan Basic Theory and Practice A common practical approach: WACC = Weighted Average Cost of Capital Look ahead: CAPM = Capital Asset Pricing Model Massachusetts Institute

### Sales Training Programme. Module 7. Objection handling workbook

Sales Training Programme. Module 7. Objection handling workbook Workbook 7. Objection handling Introduction This workbook is designed to be used along with the podcast on objection handling. It is a self

### Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS. Peter N. Ireland Department of Economics Boston College. irelandp@bc.edu

Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS Peter N. Ireland Department of Economics Boston College irelandp@bc.edu http://www2.bc.edu/~irelandp/ec261.html Chapter 16: Determinants of the Money

### What accounting students should know about the price-earnings ratio

ABSTRACT What accounting students should know about the price-earnings ratio Dean W. DiGregorio Southeastern Louisiana University The price-earnings ratio (P/E ratio) is a valuation multiple that can be

### PERPETUITIES NARRATIVE SCRIPT 2004 SOUTH-WESTERN, A THOMSON BUSINESS

NARRATIVE SCRIPT 2004 SOUTH-WESTERN, A THOMSON BUSINESS NARRATIVE SCRIPT: SLIDE 2 A good understanding of the time value of money is crucial for anybody who wants to deal in financial markets. It does

### Bonds and the Term Structure of Interest Rates: Pricing, Yields, and (No) Arbitrage

Prof. Alex Shapiro Lecture Notes 12 Bonds and the Term Structure of Interest Rates: Pricing, Yields, and (No) Arbitrage I. Readings and Suggested Practice Problems II. Bonds Prices and Yields (Revisited)

### Beginners Guide to Asset Allocation, Diversification, and Rebalancing

Beginners Guide to Asset Allocation, Diversification, and Rebalancing Even if you are new to investing, you may already know some of the most fundamental principles of sound investing. How did you learn

### Fundamentals Level Skills Module, Paper F7. Section B

Answers Fundamentals Level Skills Module, Paper F7 Financial Reporting September/December 2015 Answers Section B 1 (a) Moston Statement of profit or loss and other comprehensive income for the year ended

### A Unique and Potentially Effective Method of Capital Formation in Today s Financing Environment

Reverse Mergers A Unique and Potentially Effective Method of Capital Formation in Today s Financing Environment Prepared by MDB Capital Group LLC March 2003 Background Reverse mergers have been utilized

### Valuation Issues. Treatment of Minority Interest, Investments in Associates & Other Investments. Part 1 Concept & Accounting

Part 1 Concept & Accounting? What is Minority nterest? Put simply, it is the stake the minor (i.e. non-controlling) investor/s has/have in the Consolidated company. E.g. company H holds a 70% stake in

### The Capital Asset Pricing Model (CAPM)

Prof. Alex Shapiro Lecture Notes 9 The Capital Asset Pricing Model (CAPM) I. Readings and Suggested Practice Problems II. III. IV. Introduction: from Assumptions to Implications The Market Portfolio Assumptions

### Chapter 9. The Valuation of Common Stock. 1.The Expected Return (Copied from Unit02, slide 36)

Readings Chapters 9 and 10 Chapter 9. The Valuation of Common Stock 1. The investor s expected return 2. Valuation as the Present Value (PV) of dividends and the growth of dividends 3. The investor s required

### 140 SU 3: Profitability Analysis and Analytical Issues

140 SU 3: Profitability Analysis and Analytical Issues QUESTIONS 3.1 Profitability Ratios Questions 1 and 2 are based on the following information. The financial statements for Dividendosaurus, Inc., for

### Stock valuation. Price of a First period's dividends Second period's dividends Third period's dividends = + + +... share of stock

Stock valuation A reading prepared by Pamela Peterson Drake O U T L I N E. Valuation of common stock. Returns on stock. Summary. Valuation of common stock "[A] stock is worth the present value of all the

### Source of Finance and their Relative Costs F. COST OF CAPITAL

F. COST OF CAPITAL 1. Source of Finance and their Relative Costs 2. Estimating the Cost of Equity 3. Estimating the Cost of Debt and Other Capital Instruments 4. Estimating the Overall Cost of Capital

### Quick Start Guide Getting Started with Stocks

Quick Start Guide Getting Started with Stocks Simple but Sophisticated Don t let the name fool you: the scan may be simple, but behind the curtain is a very sophisticated process designed to bring you

### MANAGEMENT OPTIONS AND VALUE PER SHARE

1 MANAGEMENT OPTIONS AND VALUE PER SHARE Once you have valued the equity in a firm, it may appear to be a relatively simple exercise to estimate the value per share. All it seems you need to do is divide

### ECON4510 Finance Theory Lecture 7

ECON4510 Finance Theory Lecture 7 Diderik Lund Department of Economics University of Oslo 11 March 2015 Diderik Lund, Dept. of Economics, UiO ECON4510 Lecture 7 11 March 2015 1 / 24 Market efficiency Market

### Market Efficiency and Behavioral Finance. Chapter 12

Market Efficiency and Behavioral Finance Chapter 12 Market Efficiency if stock prices reflect firm performance, should we be able to predict them? if prices were to be predictable, that would create the

### Chapter 17 Financial Forecasting and Planning

Chapter 17 Financial Forecasting and Planning Slide Contents Learning Objectives 1. An Overview of Financial Planning 2. Developing a Long-term Financial Plan 3. Developing a Short-Term Financial Plan

### U.S. Fixed Income: Potential Interest Rate Shock Scenario

U.S. Fixed Income: Potential Interest Rate Shock Scenario Executive Summary Income-oriented investors have become accustomed to an environment of consistently low interest rates. Yields on the benchmark

### hp calculators HP 17bII+ Net Present Value and Internal Rate of Return Cash Flow Zero A Series of Cash Flows What Net Present Value Is

HP 17bII+ Net Present Value and Internal Rate of Return Cash Flow Zero A Series of Cash Flows What Net Present Value Is Present Value and Net Present Value Getting the Present Value And Now For the Internal

### Financial Evolution and Stability The Case of Hedge Funds

Financial Evolution and Stability The Case of Hedge Funds KENT JANÉR MD of Nektar Asset Management, a market-neutral hedge fund that works with a large element of macroeconomic assessment. Hedge funds

### Chapter 10. Key Ideas Correlation, Correlation Coefficient (r),

Chapter 0 Key Ideas Correlation, Correlation Coefficient (r), Section 0-: Overview We have already explored the basics of describing single variable data sets. However, when two quantitative variables

### CHAPTER 23: FUTURES, SWAPS, AND RISK MANAGEMENT

CHAPTER 23: FUTURES, SWAPS, AND RISK MANAGEMENT PROBLEM SETS 1. In formulating a hedge position, a stock s beta and a bond s duration are used similarly to determine the expected percentage gain or loss