Public Corporation Final Exam Outline
Valuation
E(C)MH – Efficient Market Hypothesis
Weak Efficiency
Prices reflect the information contained in the record of past prices
Semi-Strong
Prices reflect not only past prices, but all other published information
Strong
Prices reflect all information that can be obtained by full painstaking analysis of the both the company and the economy
Speculative Efficiency
Information thought to be relevant is immediately priced in
Stale information is of no value in making money
Allocative Efficiency
Definite relationship between market prices and the firm’s “true” value
Price reflects rational treatment of information by investors
Price should neither over- nor under-react to information
Price shouldn’t move at all in absence of new information
Noise Trading
This approach relies on two assumptions
Some investors are not fully rational and their desire for risky assets is affected by their beliefs & sentiments that are not fully justified by market information
Arbitrage is risky & therefore limited
Arbitrage is trading by fully rational investors not subject to the effects of sentiment
Changes in investor sentiment not fully countered by arbitrageurs
This approach seems to be superior to the efficient market paradigm
Arbitrage is limited by:
Fundamental Risk
Risk of unpredictability of future resale price
All investor behavior affects price
Discounting Returns to PV
“You’re getting $X in 20 years, what is that worth today?”
Terminology
Discount = future set of finite payments
e.g. PV of finite number of future payments ($10 over 10 years)
Capitalization = future payments in perpetuity
Multiplier = reciprocal of Discount rate
Value of multiplier = earnings/income from investment * discount rate
V = I * R
Future Value of a Present Sum
FVn = x(1+k)n
FVn = amount being determined
n = units of time (years, months, etc)
x = current sum of money being invested
k = rate of return express as decimal
make sure this is the same units as n!!!
Present Value of a Lump Sum
PV = (Xn) / (1 + k)n
(1 + k)n is the present value factor
Tables for Values
Table 11-1 for Discounted Present Value
Table 11-2 for Compound Interest
Table 11-3 for Value of an Income Stream/Annuity
Return Issues
Expected Returns/Depreciation as component?
Expected Retu
utstanding Shares linked back to cash flow or book value
Comparative acquisition approach
Sale prices of similar firms as going concerns, not aggregate of secondary market numbers (control premium problem)
Discounted Cash Flow is more qualitative than other approaches
Constant v. Non-constant growth assumptions
Typically there is rapid early growth then plateaus later on
Constant growth Return = (d / MP) + g
d = annual dividend
MP = market price
g = growth rate (often an estimate)
“Life cycle” of firm’s earnings patterns
Market Capitalization Rates
Given a choice among a number of projects, and investor will ALWAYS choose the one with the highest expected return PROVIDED THAT the projects all have similar degrees of risk
P/E Ratio is often used as a valuation multiplier
Risk Aversion as a factor
Is a factor for an investor/company when choosing what type of projects to take on
Table of Risk for different investments
