400 IB - ADVANCED DCF EXAM
QUESTIONS AND ANSWERS 100%
CORRECT.
If im working with a public company in a DCF, how do I calculate its per-share value? -
ANSWEROnce you get to enterprise value, add cash and then subtract debt, perferred
stock, and noncontrolling interests to get equity value.
Then you need to use a circular calculation that takes into account the basic shares
outstanding, options, warrants, convertibles, and other dilutive securities. Its circular
because the dilution from these depends on the per-share price, but the per-share price
depends on the number of shares outstanding which depends on the per-share price.
How does the terminal value change when we use the mid-year convention? -
ANSWERWhen your discounting the terminal value back to the present value, you use
different numbers for the discount period depending on whether your using the Gordon
Growth method or Multiples method.
1. Project out the company's earnings, down to earnings per share (EPS)
2. Assume a dividend payout ratio - what percentage of the EPS actually gets paid out
to shareholders in the form of dividends - based on what the firm has done historically
and how much regulatory capital it needs
3. Use this to calculate dividends over the next 5-10 years
4. Do a check to make sure that the firm still meets its target Tier 1 Capital and other
capital ratios - if not, reduce dividends. 5. Discount the dividend in each year to its
present value based on Cost of Equity - NOT WACC - and then sum these up
6. Calculate terminal value based on P / BV and Book Value in the final year, and then
discount this to its present value based on Cost of Equity
7. Sum the present value of the terminal value and the present values of the dividends
to get the company's net present per-share value.
Multiples: you add 0.5 to the final year discount numbers to reflect the fact that you're
assuming the company gets sold at the end of the year
Explain why we use the mid-year convention in a DCF? - ANSWERYou use it to show
that a company's cash flow does not come 100% at the end of the year, but rather
evenly throughout the year.
In a DCF without mid-year conventions, we would use discount period numbers of 1 for
the first year, 2 for the second year, and so on...
With mid-year convention, we would instead use .5 for the first year, 1.5 for the second,
and so on...
QUESTIONS AND ANSWERS 100%
CORRECT.
If im working with a public company in a DCF, how do I calculate its per-share value? -
ANSWEROnce you get to enterprise value, add cash and then subtract debt, perferred
stock, and noncontrolling interests to get equity value.
Then you need to use a circular calculation that takes into account the basic shares
outstanding, options, warrants, convertibles, and other dilutive securities. Its circular
because the dilution from these depends on the per-share price, but the per-share price
depends on the number of shares outstanding which depends on the per-share price.
How does the terminal value change when we use the mid-year convention? -
ANSWERWhen your discounting the terminal value back to the present value, you use
different numbers for the discount period depending on whether your using the Gordon
Growth method or Multiples method.
1. Project out the company's earnings, down to earnings per share (EPS)
2. Assume a dividend payout ratio - what percentage of the EPS actually gets paid out
to shareholders in the form of dividends - based on what the firm has done historically
and how much regulatory capital it needs
3. Use this to calculate dividends over the next 5-10 years
4. Do a check to make sure that the firm still meets its target Tier 1 Capital and other
capital ratios - if not, reduce dividends. 5. Discount the dividend in each year to its
present value based on Cost of Equity - NOT WACC - and then sum these up
6. Calculate terminal value based on P / BV and Book Value in the final year, and then
discount this to its present value based on Cost of Equity
7. Sum the present value of the terminal value and the present values of the dividends
to get the company's net present per-share value.
Multiples: you add 0.5 to the final year discount numbers to reflect the fact that you're
assuming the company gets sold at the end of the year
Explain why we use the mid-year convention in a DCF? - ANSWERYou use it to show
that a company's cash flow does not come 100% at the end of the year, but rather
evenly throughout the year.
In a DCF without mid-year conventions, we would use discount period numbers of 1 for
the first year, 2 for the second year, and so on...
With mid-year convention, we would instead use .5 for the first year, 1.5 for the second,
and so on...
