Wednesday, January 4, 2012

CFA Level 2 Equity & Corporate Finance


Abstract: Two of core finance areas for the CFA is Equity and Corporate, and much of Equity valuation depend on them.


Introduction:
Equity valuations like DCF & multiple based valuations comes in this area.
And the much talked about Investment banking comes in Corporate Finance.

4 areas of working are:
  1. DDM & FCF
  2. Multiples (Deriving the mathematical formula of multiples and when they are used) including EBITDA EV multiples which are again very interesting
  3. Residual Income (various models of RI, again formula derivation is imp)
  4. Private Company Valuation
These 4 pillar forms the base of equity research. The questions will require corporate Finance and Financial Reporting Analysis to compute free cash flows, or CFO through indirect method.
These question are also used a company during merger or spinoffs. I got a question in Finance exam, a case of merger and then spinoff where we have to use different models. Hence this question became a mix of M&A and Equity.

Spinoffs also use a lot of Equity valuation to decide the rates and ratios. In my question they used P/B multiple.


Some of the other things in Private Equity are covered in Alternative Assets.


FCFF Valuation on Excel:
Damodaran:
  1. EBIT norm
  2. RnD
  3. Lease Conversion

FCFF Stages:
VF
EV
VE
Price of Share

All things boil down to find out the EBIT and other parameters that grows over a period of time.

Investment Banking:
This area is the best, what I came to know from this area is investment banking is more of MBA which requires a lot of maturity, marketing and negotiation as synergy and such things are very subjective. Two methods were taken from FCFF from the accounting point of view, and other was based on market. Both of them were very interesting. Again multiple based valuation and other requires good accounting, and what I tend to believe is CFA is more about equity valuation and such kind of profiles. But today when I looked at the course of Mater of financial engineering from various sites I came to know that Financial Engg is less about Equity and more about risk and technical analysis.


Ratio in Equity valuation is another important areas: Multiple based valuations.

Two things that are tough to understand are Working capital and Capital Expenditure which needs to looked upon carefully in understanding the Free cash flows as most of them are from indirect methods.

They are sometimes known as trading and transaction multiples. EV multiples coupled with other reports helps a lot in investment banking where you are paying for control. EV is market cap+ debt - cash. Another interesting thing is patent valuation and adjust of items for EBITDA. This is most MnA we use the transaction multiples. Companies of same categories are tough to find. Normalization of earning is hence an important work to do. Also calendarization of statements is imp to do an apple to apple comparison.

Lagging and leading indicators terminology is often used.


Conclusion:
It is all about EV multiples or transaction multiples from the past activities for IB.

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