Firm Valuation Overview
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Firm Valuation Overview

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@VersatileGulf

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Questions and Answers

What does firm valuation reveal?

Key factors driving a company's success and insights into its growth potential and profitability.

What is the formula for Earnings per Share (EPS)?

Profit divided by outstanding shares of common stock.

What does the return on capital measure?

How well the company uses its money to make more money.

Long-term value creation often requires consideration of only the interests of shareholders.

<p>False</p> Signup and view all the answers

Which of the following is NOT a purpose of firm valuation?

<p>Short-term Marketing Strategies</p> Signup and view all the answers

What may harm long-term prospects when focusing on short-term financial gains?

<p>Cutting essential investments such as research and development and marketing.</p> Signup and view all the answers

What is intrinsic value based on?

<p>Future expected cash flows or earnings.</p> Signup and view all the answers

What does Total Shareholder Returns (TSR) measure?

<p>Percent Change in Market Value plus Dividend Yield.</p> Signup and view all the answers

Higher expectations always lead to better stock market performance.

<p>False</p> Signup and view all the answers

The rate or magnitude of increase in a company's revenue is known as _____ over time.

<p>growth</p> Signup and view all the answers

What is the focus of the financial market?

<p>Managing investor perceptions and expectations.</p> Signup and view all the answers

Study Notes

Firm Valuation Overview

  • Firm valuation reveals key factors driving a company's success, providing insights into its growth potential and profitability.
  • Key factors driving firm valuation are growth, return on capital, and cost of capital.
  • Companies should consider the interests of all stakeholders, not just shareholders, in their decision-making processes.
  • Long-term value creation requires considering social, environmental, and ethical implications of business activities.
  • Many managers and investors prioritize short-term financial metrics, such as earnings per share (EPS), over long-term value creation.
  • Short-term focus can lead to damaging decisions that harm long-term prospects, such as cutting essential investments.
  • EPS as a performance measure may not reflect the true value created by a company.
  • Share price and EPS do not always align with intrinsic value.

Objective of Firm Valuation

  • Firm valuation aims to determine the fair value of a company's assets, operations, and future cash flows.
  • This valuation is essential for various purposes, including:
    • Investment Decision Making
    • Mergers and Acquisitions
    • Financial Reporting
    • Fundraising and Capital Allocation
    • Litigation and Dispute Resolution

Value Creation in the Real Market

  • Companies create value when they earn a return on invested capital (ROIC) greater than their opportunity cost of capital.
  • Growth may not create value if the ROIC is at or below the cost of capital.
  • ROIC = after-tax operating profit divided by invested capital (working capital plus fixed assets).
  • Growth = the rate of increase in a company's revenue, earnings, or market share over a specific period.

Value Creation in the Financial Market

  • The focus shifts from creating value through operations to managing investor perceptions and expectations.
  • Goal: actual performance exceeding investors’ anticipation impacts share price.
  • Intrinsic Value = based on future expected cash flows or earnings.
  • Share Price = influenced by investors' expectations of future performance relative to the company's performance.

Alchemy of Stock Market Performance

  • A commonly used measure for evaluating company performance and management is total shareholder returns (TSR).
  • TSR = percent change in market value + dividend yield.
  • TSR is heavily influenced by changes in investors' expectations.
  • Expectation Treadmill: High expectations continuously pressure for exceptional performance.
  • Companies with low expectations may outperform the stock market due to easier targets to surpass.
  • The Decision Rule in the Real Market: Choose strategies or make operational decisions that maximize the present value of future cash flow.

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Related Documents

S1 Firm Valuation PDF

Description

Explore the essential aspects of firm valuation and understand the key factors that drive a company's success. This overview emphasizes the importance of long-term value creation and the need to consider all stakeholders in business decisions. Learn how short-term financial metrics can distort true company value and the implications of environmental and ethical considerations.

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