Asset Valuation Flashcards

In a two-stage dividend discount model, the terminal value at the end of Stage 1 is calculated using:

Answer: The Gordon Growth Model applied to Stage 2 dividends

The terminal value applies the constant-growth Gordon model to the first dividend of Stage 2, then discounts it back.

Which of the following best describes the concept of a 'margin of safety' in value investing?

Answer: Purchasing an asset at a price significantly below its intrinsic value

Margin of safety is the discount between market price and intrinsic value, providing a buffer against estimation errors.

Residual income for equity valuation is defined as net income minus:

Answer: The equity charge (beginning book value × cost of equity)

Residual income = Net income − (r_e × BV_equity_{t-1}), representing value created above the required return on equity.

When the required rate of return equals the growth rate in the Gordon Growth Model, the stock value is:

Answer: Undefined because the denominator equals zero

The denominator (k − g) becomes zero, making the formula undefined and implying infinite value, which is economically impossible.

Which of the following is an example of an asset-based valuation approach?

Answer: Estimating net asset value by marking assets to fair value

Asset-based valuation estimates equity value as fair value of assets minus fair value of liabilities, yielding NAV.

A company has EBITDA of $50M and comparable firms trade at an EV/EBITDA of 8x. If the company has $60M of net debt, what is its estimated equity value?

Answer: $340M

EV = 8 × $50M = $400M; Equity value = $400M − $60M net debt = $340M.

In the context of bond valuation, duration measures:

Answer: The average time to receive the bond's cash flows, weighted by present value

Duration is the present-value-weighted average time to receive all cash flows and approximates price sensitivity to yield changes.