SD16- A theory of multiples

SD16- A theory of multiples - CHAPTER 16 A THEORY OF...

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CHAPTER 16 A “THEORY” OF MULTIPLES LEARNING OBJECTIVES 1. How and why analysts use the multiples approach to value companies. 2. What are the arguments for and against using multiples to value companies. 3. Why the multiples approach requires that firms be comparable. 4. How to identify comparable firms. 5. How earnings quality issues affect comparability in the multiples approach. 6. How the multiples approach can be an acceptable shortcut to discounted cash flow valuation. TRUE/FALSE QUESTIONS 1. Research has shown that multiples such as the price/earnings and market/book ratios can be used to predict future stock returns, suggesting that firms with low multiples are undervalued and multiples can be used to rank investments. (moderate, L.O. 1, Section 1, true) 2. In the multiples valuation, the forecast is summarized using many variables as in the cash flow models. (moderate, L.O. 1, Section 1, false) 3. The analyst is comparing “apples and oranges” if the consistency requirements are not met for the multiples formula. (easy, L.O. 1, Section 1, true) 4. When the analyst examines several firms, it is unlikely that their multiples will be identical. (moderate, L.O. 1, Section 1, true) 5. The analyst will use different steps when using a multiple to estimate the value of a company’s equity. (moderate, L.O. 1, Section 1, false) 6. The multiples approach requires only one explicit assumption whereas the discounted cash flow model requires several explicit assumptions. (moderate, L.O. 1, Section 1, true) 7. Arguments for and against the use of the multiples approach can both be correct when placed in the proper context. (difficult, L.O. 2, Section 2, true) 8. The multiples approach is less scientific because it does not involve a number of assumptions. (moderate, L.O. 2, Section 2, false) 9. An analyst can use the multiples approach, but the analyst must understand that doing so is only valid when it is acknowledged that cash flow actually creates value and the multiples analysis is a shortcut to valuing cash flow. (difficult, L.O. 2, Section 2, true) 10. The key step in a successful multiples valuation is using a discounted cash flow analysis of the target firm to support the multiples valuation findings. (moderate, L.O. 3, Section 3, false) 11. Many variables differ across firms, yet, to be comparable, firms do not need to have similar values for all of these variables. 108
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(moderate, L.O. 3, Section 3, false) 12. In looking at a list of potentially comparable firms, an analyst should check to see that the comparable firms’ capital structures are similar to that of the target firm. (moderate, L.O. 4, Section 4, true) 13. When using a multiples approach, an analyst should always use the total earnings of a firm rather than EPS.
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This note was uploaded on 11/22/2010 for the course CAC BSA taught by Professor Kairus during the Spring '10 term at Korea University.

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SD16- A theory of multiples - CHAPTER 16 A THEORY OF...

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