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标题: Equity Valuation【 Reading 35】Sample [打印本页]
作者: bapswarrior    时间: 2012-3-30 15:55     标题: [2012 L2] Equity Valuation【Session 10- Reading 35】Sample

Laura’s Chocolates, is a maker of nut-based toffees. The company holds shares in one of its suppliers, and wants to know what the holding period return was last year.

January 1 (purchase date)

$40


December 31

$45


Dividend paid (December 31)

$5


Cost of equity

11%


Cost of debt

8%


Debt : equity

1:3


What is the holding period return (ignore taxes)?
A)
12.50%.
B)
25.00%.
C)
22.50%.


作者: bapswarrior    时间: 2012-3-30 15:55

To determine the present value of an investment based on a future estimate of the investment’s value, an analyst should use the:
A)
discount rate.
B)
required return.
C)
internal rate of return.


The discount rate is the rate used to find the present value of an investment.
作者: bapswarrior    时间: 2012-3-30 15:56

In an efficient market, a mutual fund’s required return is the same as the:
A)
internal rate of return.
B)
holding period return.
C)
net asset value return.


The internal rate of return (IRR) is the rate that equates the value of the discounted cash flows to the current price of the security. In an efficient market, where securities are properly priced, the IRR and required return are the same.
作者: bapswarrior    时间: 2012-3-30 15:56

Ben Jacobs, CFA, is attempting to calculate a historical equity risk premium. His first estimate uses geometric mean equity returns and long-term bond yields. His second estimate uses arithmetic mean returns and short-term bond yields. The effect of the changes in methodology in the second estimate, relative to the first, will:
A)
both increase the size of the risk premium.
B)
both decrease the size of the risk premium.
C)
have offsetting effects.


Switching from a geometric mean to an arithmetic mean will increase the mean equity return. All else being equal, that will increase the estimated risk premium. When the yield curve slopes upward, short-term bonds yield less than long-term bonds. Thus, the equity risk premium estimate will be larger when short-term bond rates are used.
作者: bapswarrior    时间: 2012-3-30 15:57

An analyst attempting to derive the equity risk premium for a stock starting from the required return for that stock would find which of the following statistics least useful?
A)
The stock’s beta.
B)
Historical 10-year Treasury bond rates.
C)
The stock’s estimated return.


The required return for a stock is equal to the risk-free return plus beta times the equity risk premium. An analyst starting from the required return would need beta and a risk-free rate. Historical 10-year T-bond rates can be used as an estimate of the risk-free rate. Since the analyst is starting with the required return, estimated returns are not needed.
作者: bapswarrior    时间: 2012-3-30 15:57

The equity risk premium is the difference between:
A)
the estimated equity return and the risk-free return.
B)
estimated equity returns and estimated bond returns.
C)
the required equity return and the risk-free return.


The equity risk premium reflects the return in excess of the risk-free rate that investors require for holding stocks. It is derived by subtracting the risk-free return from the required return.
作者: sabaruch    时间: 2012-3-30 16:02

Equity analyst Yasmine Cordova of Substantial Securities is trying to determine the investment appeal of shares of Maxwell Mincemeat, a small food company. Cordova has assembled the following data about the company:
Cordova wants to make sure her estimates are accurate, so she decides to calculate the estimated required return in two ways. She opts for the bond-yield plus risk premium method and the capital asset pricing model. To check her work, she wants to compare the estimates derived under each method. The difference between the required returns is closest to:
A)
5.30%.
B)
9.29%.
C)
5.89%.


The capital asset pricing model uses the following equation:

Required return = risk-free rate + beta × equity risk premium

To calculate the required return under CAPM, use the Russell 2000 index return, the beta, and the risk-free rate.

Required return = 3.4% + 2.1 × (12.3% − 3.4%) = 22.09%.

The bond-yield model uses the following equation:

Required return = yield to maturity on long-term bonds + risk premium.

Required return = 7.9% + 4.9% = 12.8%.

The difference between the two estimated required returns is 9.29%.
作者: sabaruch    时间: 2012-3-30 16:03

Jaden Hoyle is evaluating the MegaFood Market chain of grocery stores and Strinson Carburetors, a maker of automobile and industrial engine parts. MegaFood is publicly traded, while Strinson is a private company. Hoyle’s firm, Janssen and Associates, is considering the purchase of a 50% equity stake in one or both of the companies, and may be willing to purchase the companies outright. Janssen only invests in companies with a weighted average cost of capital of less than 11%.
Hoyle has assembled the following data on the two companies:


MegaFood Market
Strinson Carburetors

Beta
0.87

Market value of equity
$173 million
$993 million

Market value of debt
$38 million
$567 million

Marginal tax rate
42.8%
31%

Target debt/equity rating
35%
78%

Equity risk premium

4.6%

Required return on debt
9%
6.5%

The risk-free rate of return is 5.2%. Hoyle must make recommendations regarding both MegaFood Market and Strinson Carburetors.
Hoyle does not have all of the data she needs and knows she will have to estimate some values using the data she does possess. To help estimate the required return on equity for Strinson Carburetors, Hoyle takes three actions:
Action A: She selects a benchmark company, unlevers the beta of that company, then levers up the adjusted beta using Strinson’s debt and equity allocation.
Action B: She calculates a risk premium, then adds that premium to the yield to maturity of the company’s long-term debt.
Action C: She prepares a supply-side multifactor model considering expected inflation, expected GDP growth, and expected changes in P/E ratio.
Before she finishes her analysis of MegaFood Market and Strinson Carburetors, Hoyle must construct valuation models for two other companies, Halberd Hardware, a maker of hand tools, and the Jones Group, one of the world’s largest consultants. She has assembled the following information about each company. Halberd Hardware Jones Group
For her analysis of Halberd Hardware, Hoyle is considering three models to calculate the estimated return. But she has already decided to use the Gordon Growth model to calculate the equity risk premium.
As soon as Hoyle finishes determining which models are best suited to her purposes, her boss comes into the office and tells her to use the capital asset pricing model (CAPM) for all four of the companies she is reviewing. Hoyle is concerned about the effectiveness of the CAPM. With regards to Jones Group, her three main worries are: Worry A: The need to use the country spread model to revise the equity risk premium.
Worry B: The CAPM’s effectiveness because of Jones Group’s ADR.
Worry C: The need to create a beta estimate using an unlevered beta.
Assuming MegaFood Market has a required return on equity (ROE) of 13.6% and Strinson Carburetors has a required ROE of 15.3%, what recommendation should Hoyle give her superiors at Janssen regarding each company?
MegaFood MarketStrinson Carburetors
A)
Don’t buy the companyBuy the company
B)
Don’t buy the companyDon’t buy the company
C)
Buy the companyBuy the company


To determine whether the investments fit Janssen’s requirements, we must calculate the weighted average cost of capital. We have the target debt/equity ratio, from which we can derive the debt/capital ratio needed to calculate WACC. Debt/capital = (debt / equity) / (1+ debt / equity)
For MegaFood, the target debt/capital ratio is 25.93%. For Strinson, the target debt/capital ratio is 43.82%.
WACC = [debt / capital × required return on debt × (1 − tax rate)] + (equity / capital) × required return on equity.
MegaFood WACC = [(25.93% × 9% × (1 − 42.8%)] + (1 − 25.93%) × 13.6% = 11.41%.
Strinson WACC = [(43.82% × 6.5% × (1 − 31%)] + (1 − 43.82%) × 15.3% = 10.56%.
For MegaFood, WACC is 11.41%, higher than the Janssen’s 11% target. For Strinson, WACC is 10.56%, below the target. Thus, Janssen should buy Strinson, but not MegaFood.
(Study Session 10, LOS 35.g)

Which of Strinson’s actions is least helpful in the calculation of required return on equity for Strinson Carburetors?
A)
Action B.
B)
Action A.
C)
Action C.


Action A is a useful method for calculating beta for private or thinly traded companies. With that estimated beta, Hoyle has all the pieces needed to calculate required return using the capital asset pricing model. Action B reflects the bond-yield plus risk premium method for calculating required return on equity for companies with publicly traded debt. This strategy would provide Hoyle with a target return. The model created in Action C is useful for estimating an equity risk premium. But Hoyle already has an equity risk premium. (Study Session 10, LOS 35.b)
Which of the following is the best model for calculating Strinson Carburetors’ required return?
A)
Fama-French model.
B)
Pastor-Stambaugh model.
C)
Capital asset pricing model.


Strinson is not publicly held, and its shares have little liquidity. The Fama-French model is useful for estimating returns, but the Pastor-Stambaugh model adds a liquidity factor to the Fama-French model. As such, the Pastor-Stambaugh model is probably better for a company like Stinson because it takes liquidity into account. The CAPM requires the estimation of beta and is likely to be less accurate than the other models. (Study Session 10, LOS 35.c)

Hoyle wants to calculate an expected return for Halberd Hardware and Jones Group. She has access to a variety of models, but her best option is:
for Halberdfor Jones
A)
build-up methodcountry spread model
B)
build-up methodcapital asset pricing model
C)
bond-yield plus
risk premium method
capital asset pricing model


Both the build-up method and the bond-yield plus risk premium method work for thinly traded companies. But the build-up method relies on historical estimates, so it wouldn’t work well for Halberd, which has minimal historical data. Thus, the bond-yield plus risk premium method is the best option. The country spread model is not designed to calculate an expected return, but instead to adjust data from emerging markets for comparison with data from developed markets. The question only provides two options, and the CAPM is the only model that would actually do the required job for Jones. (Study Session 10, LOS 35.c)
Hoyle wants to use a macroeconomic model to derive equity risk premiums for both Halberd Hardware and Jones Group. Such a model is appropriate for:
A)
both Halberd Hardware and Jones Group.
B)
Jones Group, but not Halberd Hardware, because macroeconomic models don’t work for closely held companies.
C)
Halberd Hardware, but not Jones Group, because macroeconomic models don’t work for nations like South Pittson Island.


Macroeconomic models work for any market in which public equities represent a large enough share of the economy that analysts can reasonably infer a relationship between economic factors and asset prices. Since South Pittson Island is known as a tax haven, it is likely that many other companies are domiciled there for the same reason Jones Group is, and the financial industry is a large part of the economy. However, even if we don’t want to assume that South Pittson Island’s economy is suitable for such models, we have another argument. Jones Group is one of the world’s largest consulting companies. Therefore, it is highly likely that it has significant operations in large, developed markets. Macroeconomic models can be constructed to reflect data from those markets – and in fact, any such model should reflect that data.
While Halberd is closely held, that status should not affect a macroeconomic model, which looks at broad factors that affect both public and private companies. We need not have a beta or historical trading data to use such a model. (Study Session 10, LOS 35.c)

Which of Hoyle’s worries about using the CAPM for Jones Group is most justified?
A)
Worry B.
B)
Worry A.
C)
Worry C.


Currency-translation issues are a concern for any company with operations in foreign countries. But the country spread model is designed to adjust results from emerging markets using data from developed markets, assigning the proper amount of extra risk for the emerging market. Most tax havens would not need to be treated as emerging markets. In addition, as one of the world’s largest consultancies, Jones Group must do a lot of business in the U.S. and other developed markets. It is unlikely that results from a company like Jones Group would require the adjustments from the country spread model. Regarding beta: Since Jones is publicly traded, there is no need to extrapolate a beta using data from another company. Thus, there is no reason to unlever beta from a benchmark company, then relever it to reflect Jones’ financial condition. The biggest concern is the overall effectiveness of the CAPM. The model should work for Jones Group, but it has weaknesses, most importantly its dependence on just one factor. Jones trades on at least two exchanges, and any model depending on just one market index is not going to reflect the whole picture. (Study Session 10, LOS 35.f)
作者: sabaruch    时间: 2012-3-30 16:04

Analyst Charlie Howell, CFA, is trying to calculate the required return on equity for Yazz Jazz, a maker of saxophones. However, Yazz Jazz operates in a country with rapidly changing inflation rates. Which method should Howell use?
A)
Build-up.
B)
A multifactor model.
C)
Bond-yield plus risk premium.


The build-up method assigns premiums based on company size and other company-specific factors. It is designed for use on closely held companies and does not take inflation changes into account. The bond-yield method adds a risk premium to the yield on the company’s publicly traded debt. The bond yields will reflect inflation indirectly, but the model does not easily adjust for inflation changes. For taking rapid inflation changes into account, a multifactor model works the best.
作者: sabaruch    时间: 2012-3-30 16:04

Analyst Charlie Howell, CFA, has constructed two models for determining the required return on equity for Yazz Jazz, a saxophone maker. One takes the company’s size into account, the other takes the shares’ liquidity into account. Which of the following pairs of equity-return models require the use of:
SizeLiquidity
A)
Build-upPastor-Stambaugh
B)
Capital asset pricing modelFama-French
C)
Build-upFama-French


The build-up method takes into account a company’s size and is usually applied to closely held companies for which beta is not available. The Pastor-Stambaugh method is a modified version of the Fama-French factor model that considers liquidity.
作者: sabaruch    时间: 2012-3-30 16:05

Morgan Bondillo, CFA, is attempting to calculate the value of Smith Sprockets. She is using a supply-side model to estimate the equity risk premium and a build-up model to estimate returns.
Based on the strategies Bondillo is using, Smith Sprockets is least likely to:
A)
be closely held.
B)
need its beta adjusted for drift.
C)
be located in a developed market.


Supply-side models work best in developed countries, where public equities represent a significant share of the economy, suggesting that there is a relationship between macroeconomic variables and asset prices. The use of a supply-side model suggests Smith Sprockets is in a developed market. Build-up models are generally used for closely held companies for which betas are not easy to obtain. Bondillo’s use of a build-up model suggests Smith Sprockets is probably closely held. Betas of public companies must be adjusted for drift. However, since the use of the build-up method suggests the company is closely held and has no beta available, beta drift is probably not relevant for Smith Sprockets.
作者: sabaruch    时间: 2012-3-30 16:05

Senior analyst James Matin is instructing a room full of new hires in the finer points of equity valuation. He makes two statements:
Statement 1:“When the return you expect for a stock doesn’t match the required return, make sure you calculate a convergence yield and build that into your valuation model.”
Statement 2:“When you estimate the equity return of a thinly traded company, the Pastor-Stambaugh model is a better option than the Fama-French model.”

Do the statements represent good advice?
Statement 1Statement 2
A)
NoYes
B)
YesNo
C)
YesYes


Statement 1 is not good advice because in some cases market inefficiencies will prevent the price from converging with intrinsic value. As such, Matin’s advice is not sound. Statement 2 is good advice, as the Pastor-Stambaugh model adds a liquidity factor to the traditional Fama-French model. Such a liquidity factor would be useful in the analysis of a thinly traded stock.
作者: sabaruch    时间: 2012-3-30 16:07

Types of estimates of the equity risk premium are least likely to include:
A)
macroeconomic model estimates.
B)
ex-ante estimates.
C)
extemporized estimates.


There are four types of estimates of the equity risk premium: historical estimates, forward-looking (ex-ante) estimates, macroeconomic model estimates, and survey estimates.
作者: sabaruch    时间: 2012-3-30 16:07

There is a multistep process used to estimate the beta of nonpublic companies. What extra step must be taken to use the process on thinly traded public companies?
A)
No extra step must be taken.
B)
Beta must be reduced using a liquidity factor.
C)
Beta must be adjusted to reflect debt and equity levels.


The same procedure is used for both nonpublic and thinly traded public companies. Beta is adjusted to reflect debt and equity levels for both types of companies. The procedure for estimating beta for private or thinly traded public companies does not involve a liquidity factor.
作者: sabaruch    时间: 2012-3-30 16:09

In the process of estimating beta for a private company, unlevering the beta calculated for the publicly traded comparable company accomplishes what goal?
A)
Establishing a baseline level of leverage.
B)
Isolating market risk.
C)
Improving the accuracy of the estimate in the event that the private company’s debt is of low quality.


Market risk, also known as systematic risk, is the risk common to all assets within a certain class. Deleveraging the beta strips out the company-specific risk related to the target company’s leverage, thereby isolating market risk. Beta calculations do not require a baseline level of leverage. The equation for calculating beta for private companies assumes the company in question has high-grade debt. The deleveraging process will not help if the assumption is incorrect
作者: sabaruch    时间: 2012-3-30 16:12

Adjusted beta for public companies compensates for:
A)
leverage.
B)
changes in the market’s growth rate.
C)
drift.


An adjusted beta is a weighted average of the estimated beta and either 1.0 (the average for all stocks) or a peer mean (the beta of similar firms). The objective of an adjusted beta measure is to compensate for beta drift, or the tendency of beta to revert to 1.0 (or the industry average).
作者: sabaruch    时间: 2012-3-30 16:15

Equity analyst Mason Kramer wants to calculate the return on equity for a number of stocks. Kramer values predictive power over all other factors and is in no hurry to finish the work. Which model is Kramer’s best option?
A)
Build-up.
B)
Multifactor.
C)
Capital asset pricing.


Multifactor models are more robust than the other alternatives. They are also more complex, but given Kramer’s goals, a multifactor model makes the most sense.
作者: sabaruch    时间: 2012-3-30 16:18

Juliann Kellmann, CFA, wants to quickly and simply calculate the expected return of equity in a company with few shares outstanding. She should use:
A)
a build-up model.
B)
a multifactor model.
C)
the capital asset pricing model.


Build-up models are very simple and apply to closely held companies. CAPM does not work well with such companies. A carefully assembled multifactor model can take liquidity issues into account, but the procedure is far more complex than that of a build-up model.
作者: sabaruch    时间: 2012-3-30 16:18

If an analyst uses a build-up model to estimate a stock’s return rather than using a multifactor model or the capital asset pricing model, the analyst is probably least concerned about:
A)
simplicity.
B)
timeliness.
C)
accuracy.


The build-up model typically uses historical values as estimates. Historical data may no longer be relevant, so a user of the build-up model is probably not concerned with timeliness.
作者: sabaruch    时间: 2012-3-30 16:18

The country risk rating model:
A)
determines a risk premium for any foreign market.
B)
depends on forecasts of exchange rates.
C)
determines a risk premium for an emerging market.


The country risk rating model begins with a model from a developed country, then modifies that model with inputs from an emerging market to derive a risk premium for the emerging market. Forecasts of exchange rates may well be part of the model, but they are not a requirement
作者: sabaruch    时间: 2012-3-30 16:19

Junior analyst Quentin Haggard is struggling with a required return calculation. His main concern is compensating for exchange rate fluctuations between the country where his company is based and the home country of a portfolio of stocks he is analyzing. Haggard should calculate the return in his home country’s currency, then adjust:
A)
for expected changes in the foreign country’s currency value.
B)
for expected changes in the foreign country’s inflation rate.
C)
the beta to account for exchange-rate fluctuations.


The proper method of compensating for changes in exchange rates is to calculate the required return in the home currency, then adjust the return using forecasts for changes in the exchange rate.
作者: sabaruch    时间: 2012-3-30 16:19

Candace Elwince is attempting to calculate the required return of Skeun Inc., a machine-tool manufacturer in a small Eastern European company. Elwince has solid data from the German market but is not sure how to account for the exchange-rate risk Skeun investors would face. Her best choice for creating a risk premium is the:
A)
Gordon Growth model.
B)
difference between the bond yields of both markets.
C)
difference between the inflation rates of both markets.


The country spread model suggests an analyst can approximate the risk premium between a developed market and an emerging market by subtracting the bond yields in the developed market from yields in the emerging market.
作者: sabaruch    时间: 2012-3-30 16:20

When attempting to build a risk premium into the required returns of stocks in a developing country, an analyst should use the:
A)
modified Gordon Growth model.
B)
country’s weighted average cost of capital.
C)
country spread model.


The country spread model uses data from a developed market, then adjusts it using the difference between the bond yields for the emerging and developed markets. Neither a modified Gordon Growth model nor a weighted average cost of capital will do this job.
作者: sabaruch    时间: 2012-3-30 16:20

Marina Syltus, chief financial officer of Worcester Water Treatment, wants to know the cost of the company’s capital so it can make wiser budgeting decisions. Syltus has assembled the following data:To calculate the weighted average cost of capital, Syltus needs:
A)
the required return on debt.
B)
the target debt/equity ratio.
C)
both the required return on debt and the target debt/equity ratio.


The equation for the weighted average cost of capital is as follows:
Market value of debt / market value of debt and equity × required return on debt × (1 − tax rate) + market value of equity / market value of debt and equity × required return on equity.
As such, we need the required return on debt to determine the WACC. However, analysts normally assume debt and equity are at their target ratio to calculate the cost of capital. If the current capital allocation does not match the target weighting, we use the target weighting. Thus, we also need the target weights for debt and equity, which we can derive from a target debt/equity ratio.
作者: sabaruch    时间: 2012-3-30 16:20

For an analyst seeking to value an entire company, the best tool is the:
A)
capital asset pricing model.
B)
weighted average cost of capital.
C)
Pastor-Stambaugh model.


The capital asset pricing model and Pastor-Stambaugh models are used to calculate the required return on equity. The weighted average cost of capital is used to value an entire company
作者: sabaruch    时间: 2012-3-30 16:21

Jaime Moreno, a new hire at the venture-capital fund Burkhart Partners, has been tasked with assessing the appeal of various potential equity investments. Moreno has been given the weighted average cost of capital (WACC) for each company. To determine the value of each company’s equity, Moreno should:
A)
strip the effects of debt out of the WACC, then calculate the value of equity.
B)
calculate the equity value using the WACC, then incorporate the value of debt.
C)
calculate the firm value using the WACC, then strip out the value of debt.


WACC is used to value an entire firm. To value the equity, use the WACC to calculate the firm’s value, then subtract the market value of its long-term debt.
作者: sabaruch    时间: 2012-3-30 16:29

Joe Bates, CFA, has prepared a schedule of real cash flows for his company’s plant expansion. Bates generally uses the weighted average cost of capital to discount such cash flows, but in order to accurately determine the present value of those real cash flows, he should adjust the discount rate to reflect:
A)
expected inflation.
B)
the company’s cost of both debt and equity.
C)
expected changes in the market growth rate.


In the context of cash flows, “real” refers to inflation-adjusted cash flows. The weighted average cost of capital already takes the cost of both debt and equity into account, but this is a nominal, not a real, discount rate. The market’s growth rate is rarely relevant to cash flows to the firm and is not part of the WACC calculation.
作者: sabaruch    时间: 2012-3-30 16:30

Cash flows to the firm should be discounted at the:
A)
market’s estimated rate of return.
B)
firm’s weighted average cost of capital.
C)
rate determined by the capital asset pricing model.


The weighted average cost of capital is the preferred discount rate for cash flows to the firm, as it reflects the cost of both debt and equity.



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