Equity Valuation

1. TUTORIAL 7: FUNDAMENTAL ANALYSIS
DISCUSSION QUESTIONS
Q1. It is unrealistic to assume that revenues or income will grow at a high rate continuously.
Analysts should consider the extent that the revenues for the industry are expected to grow
and then consider the firm market shares of that industry. Most industries turnover reverts
to growth equal to the GDP growth in the long term. This means that for an individual firm
to outstrip GDP must increase its market share ie take business from competitors.
Note that after 20 years revenues for firm X would have increased to
5𝑚 (1.12)20
= $48.231𝑚
Which is more than the current turnover of the industry $45m, implying that the firm will
become a monopoly. Is this likely to occur. This can be solved as:
𝑛 =
𝑙𝑛 (
45
5
)
𝑙𝑛(1.12)
=
2.1972
0.1133
= 19.39 𝑦𝑟𝑠
Q2. Other things being equal, it is people who are the consumers of all produce and
therefore without population growth there will be no growth in demand for goods and
services unless they are supplied at a lower cost ie due to technology advances which
reduce the cost of production.
Presently economies, such as Australia, can enjoy growth beyond their country’s population
growth because they can export produce to other countries. Developing and emerging
economies, such as China, provide cheaper labour leading to lower production costs and
increased demand of goods and services produced by developed countries. However as
these economies continue to develop, real wages should also increase so that at some
future point in time growth opportunities will level off.
Individual companies and industry sectors (or even economies) may enjoy higher growth
but at the expense of other firms and industries (and economies). Consumers may extend
current consumption by borrowing but this would require others to be

2. lenders, foregoing their current consumption. At some future stage, increased consumption
can only come from population growth, which is less than 2% per annum world-wide and is
expected to be less than 1% by 2050. Food for thought.
PROBLEMS
Q1 Required:
I. Estimate the geometric growth rate in sales without any adjustments
Sales 5 = Sales 1*(1+g)^4 => g = (Sales5/Sales1)^1/4 -1
(
1,200
850
)
0.25
− 1 = 9%
II. Adjust sales for inflation and re-estimate the growth rate.
Re-estimate sales in constant dollars- doesn’t matter which year you use as a base year as
the measure will be the same.
For example, using year 5:
Inflation = CPI5/CPI1
Re-estimate Year 1𝑠𝑎𝑙𝑒𝑠 = 850(
130
115
) = $961
(
1,200
961
)
0.25
− 1 = 5.7%
For example, using year 1:
Re-estimate sales in constant dollars (year 1) and re-estimate the geometric growth rate.
Re-estimate Year 5𝑠𝑎𝑙𝑒𝑠 = 1,200(
115
130
) = $1,062
(
1,062
850
)
0.25
− 1 = 5.7%
The estimate is the same under both methods and measure ‘real’ growth
III. Forecast revenues for years 6 in nominal and real dollars employing the geometric
growth rate and assuming expected inflation for year 6 to be 5%?
Forecast in real $
𝑆𝑎𝑙𝑒𝑠 𝑦𝑒𝑎𝑟 6 = 1,200 (1.057) = $1,268.4
Forecast in nominal $
𝑆𝑎𝑙𝑒𝑠 𝑦𝑒𝑎𝑟 6 = 1,200 (1.057)(1.05) = $1,331.8
Should use real growth rate of 5.7% and expected inflation of 5%.

3. IV. Single cash flow
Real cash flow in Year 6 = 1,268.4
r = 6% PV = CF/(1+r) = 1268.4/ 1.06 = $ 1,196.6
Nominal revenue in Year 6 = 1,331.8
Using
1 + 𝑟𝑛𝑜𝑚
1 + 𝜌
− 1 = 𝑟𝑟𝑒𝑎𝑙
Rearranged rnom = 11.3% p=Inlfation =5%
PV = 1,331.8/ 1.113 = $1,196.6
Alternatively recognise that this problem can be represented as:
CFnominal = CFreal (1+ ρ)
r nominal = r real (1+ ρ) therefore the problem becomes:
𝑃𝑉 =
1,268.4 (1 + 𝜌)
(1 + 𝑟𝑟𝑒𝑎𝑙)(1 + 𝜌)
PV = 1,268.4 (1.05)/ 1.06 (1.05)= 1,331.8 / 1.113 = $1,196.6
V. Cash flows in perpetuity
Since the only factor that separates the two models is expected inflation the present
value of the two models should be the same.
Real cash flow in Year 6 = 1,268.4
r = 6% PV = =CF/r=1268.4/ .06 = $ 21,140
Nominal revenue in Year 6 = 1,331.8
This means that
𝑃𝑉 =
1,331.82
𝑟𝑛𝑜𝑚
= $21,140
Re-arranged rnom = 6.3%
Alternatively as with problem (iv) represent as:
CFnominal = CFreal (1+ ρ)
r nominal = r real (1+ ρ) therefore the problem becomes:
𝑃𝑉 =
1,268.4 (1 + 𝜌)
(𝑟𝑅𝑒𝑎𝑙 )(1 + 𝜌)
PV = 1,268.4 (1.05)/ .06 (1.05)= 1,331.8 / 0.063 = $1,196.6
𝑃𝑉 =
1,268.4 (1.05)
(0.06)(1.05)
=
1,331.82
0.063
= $21,140
Bottom line is that inflation should not impact on the value of PV providing it is accounted
for in discount rate
Q2 Revenues: NO
SUMMARY OUTPUT

4. Regression Statistics
MultipleR 0.365877458
R Square 0.133866314
Observations 14
Coefficients t Stat P-value
Intercept 3614.386287 4.244682771 0.001137977
X Variable1 -0.000861042 -1.361864223 0.198259876
Net profit: NO
SUMMARY OUTPUT
Regression Statistics
MultipleR 0.239194
R Square 0.057214
Observations 14
Coefficients t Stat P-value
Intercept 360.0374 1.30509 0.216333
X Variable1 -0.00017 -0.85336 0.410168
This means that forecast revenues and net profit should to be determined by some other
means.
Q3 Present value
PV = 1,000/ 1.15 + 950 / (1.15)2 + 975 /(1.15)3 + 1,020 / (1.15)4 + [1,020 (1.03)/ .15 -.03] 1/
(1.15)4 = 869.6 + 718.3 + 641.1 + 583.2 + 5,005.7 = $7,817.9m
Where terminal value represents the last term.