Tom Vadney, CFA, is president and CEO of Vadney Research and Advisors (VRA), a large equity research firm that specializes in providing international investment and advisory services to global portfolio managers. He has a staff of five junior analysts and three senior analysts covering industries and firms across the Americas, Europe, and Asia-Pacific regions.In a recent meeting with an institutional portfolio manager, Vadney is asked to review the differences between U.S. GAAP and International Financial Reporting Standards (IFRS) as well as provide a comprehensive industry analysis for the telecommunications sector in Europe and the Asia-Pacific region. Vadney asks Maria Mnoyan, a senior analyst covering the sector, to research the requested information for the client meeting.Prior to the meeting, Vadney and Mnoyan meet to prepare for the client presentation. They first discuss differences between U.S. GAAP and IFRS. Mnoyan states that although there will be increasing convergence between the two accounting standards, one major difference currently is that IFRS permits either the "partial goodwill" or "full goodwill" method to value the goodwill and the noncontrolling interest under the acquisition method. U.S. GAAP requires the full goodwill method. Vadney adds that U.S. GAAP requires equity method accounting for joint ventures, while under IFRS, proportionate consolidation is preferred, but the equity method is permitted.Vadney then asks Mnoyan to share her findings on the telecommunications sector. Mnoyan first presents an overview of the competitive forces that characterize the sector in the two regions. In particular, she notes that the sector in both regions is characterized by high switching costs. Vadney asks how high switching costs would affect the bargaining power of buyers and suppliers.Mnoyan firmly believes that investing in companies located in developing countries provides strong growth potential through technological change and increases in capital, labor, and savings that contribute to higher dividend levels, even if the dividend growth rate is unaffected.In her research report Mnoyan identifies several countries and industries with attractive investment potential. She notices that the telecommunications sector in one of the countries is characterized by a duopoly. The $50 billion telecom industry in another country in her analysis is dominated by h\e firms with market shares of $10 billion each.Finally, Vadney and Mnoyan discuss investment opportunities in specific firms. Mnoyan values firms using both the discounted cash flow model and the franchise value method. She makes the following statements on the franchise value method:Statement 1: A higher asset turnover ratio increases the franchise P/E ratio, one of the components of the intrinsic P/E value.Statement 2: When firms pay out profits as dividends at a higher rate, a firm's intrinsic P/E value decreases.Mnoyan's description of the growth potential of developing countries is best described through the:
Answer(s): A
The neoclassical growth theory relates technological change to increases in real GDP, savings, and capital, which in turn lead to increased investment and higher dividends. Note, however, that higher dividend levels do not imply an increase in the long-run growth in dividends, and higher savings do not affect a country's long-run economic growth rate.The endogenous growth theory holds that technological advances lead to sustainable economic growth. These advances allow developed countries to realize both higher dividend levels and long- term dividend growth rates through increased savings.Multifactor models are used in assessing asset returns and risk exposures through multiple factors such as industry and country. Factor sensitivities are estimated through multiple linear regression. Note that there is no theory called "multifactor model theory." (Study Session 11, LOS 36.a)
Tom Vadney, CFA, is president and CEO of Vadney Research and Advisors (VRA), a large equity research firm that specializes in providing international investment and advisory services to global portfolio managers. He has a staff of five junior analysts and three senior analysts covering industries and firms across the Americas, Europe, and Asia-Pacific regions.In a recent meeting with an institutional portfolio manager, Vadney is asked to review the differences between U.S. GAAP and International Financial Reporting Standards (IFRS) as well as provide a comprehensive industry analysis for the telecommunications sector in Europe and the Asia-Pacific region. Vadney asks Maria Mnoyan, a senior analyst covering the sector, to research the requested information for the client meeting.Prior to the meeting, Vadney and Mnoyan meet to prepare for the client presentation. They first discuss differences between U.S. GAAP and IFRS. Mnoyan states that although there will be increasing convergence between the two accounting standards, one major difference currently is that IFRS permits either the "partial goodwill" or "full goodwill" method to value the goodwill and the noncontrolling interest under the acquisition method. U.S. GAAP requires the full goodwill method. Vadney adds that U.S. GAAP requires equity method accounting for joint ventures, while under IFRS, proportionate consolidation is preferred, but the equity method is permitted.Vadney then asks Mnoyan to share her findings on the telecommunications sector. Mnoyan first presents an overview of the competitive forces that characterize the sector in the two regions. In particular, she notes that the sector in both regions is characterized by high switching costs. Vadney asks how high switching costs would affect the bargaining power of buyers and suppliers.Mnoyan firmly believes that investing in companies located in developing countries provides strong growth potential through technological change and increases in capital, labor, and savings that contribute to higher dividend levels, even if the dividend growth rate is unaffected.In her research report Mnoyan identifies several countries and industries with attractive investment potential. She notices that the telecommunications sector in one of the countries is characterized by a duopoly. The $50 billion telecom industry in another country in her analysis is dominated by h\e firms with market shares of $10 billion each.Finally, Vadney and Mnoyan discuss investment opportunities in specific firms. Mnoyan values firms using both the discounted cash flow model and the franchise value method. She makes the following statements on the franchise value method:Statement 1: A higher asset turnover ratio increases the franchise P/E ratio, one of the components of the intrinsic P/E value.Statement 2: When firms pay out profits as dividends at a higher rate, a firm's intrinsic P/E value decreases.The three-firm concentration ratio of the $50 billion telecom sector, and the level of the industry's concentration, respectively, is:
The three-firm concentration ratio is simply the aggregate of the market share of the three largest firms in the industry. Since each firm represents a market share of $10 / $50 = 0.20, the concentration ratio is 3 x 0.20 = 0.60, or 60%. This characterizes a relatively highly concentrated industry with little competition from each firm. (Study Session 11, LOS 36.c,d)
Tom Vadney, CFA, is president and CEO of Vadney Research and Advisors (VRA), a large equity research firm that specializes in providing international investment and advisory services to global portfolio managers. He has a staff of five junior analysts and three senior analysts covering industries and firms across the Americas, Europe, and Asia-Pacific regions.In a recent meeting with an institutional portfolio manager, Vadney is asked to review the differences between U.S. GAAP and International Financial Reporting Standards (IFRS) as well as provide a comprehensive industry analysis for the telecommunications sector in Europe and the Asia-Pacific region. Vadney asks Maria Mnoyan, a senior analyst covering the sector, to research the requested information for the client meeting.Prior to the meeting, Vadney and Mnoyan meet to prepare for the client presentation. They first discuss differences between U.S. GAAP and IFRS. Mnoyan states that although there will be increasing convergence between the two accounting standards, one major difference currently is that IFRS permits either the "partial goodwill" or "full goodwill" method to value the goodwill and the noncontrolling interest under the acquisition method. U.S. GAAP requires the full goodwill method. Vadney adds that U.S. GAAP requires equity method accounting for joint ventures, while under IFRS, proportionate consolidation is preferred, but the equity method is permitted.Vadney then asks Mnoyan to share her findings on the telecommunications sector. Mnoyan first presents an overview of the competitive forces that characterize the sector in the two regions. In particular, she notes that the sector in both regions is characterized by high switching costs. Vadney asks how high switching costs would affect the bargaining power of buyers and suppliers.Mnoyan firmly believes that investing in companies located in developing countries provides strong growth potential through technological change and increases in capital, labor, and savings that contribute to higher dividend levels, even if the dividend growth rate is unaffected.In her research report Mnoyan identifies several countries and industries with attractive investment potential. She notices that the telecommunications sector in one of the countries is characterized by a duopoly. The $50 billion telecom industry in another country in her analysis is dominated by h\e firms with market shares of $10 billion each.Finally, Vadney and Mnoyan discuss investment opportunities in specific firms. Mnoyan values firms using both the discounted cash flow model and the franchise value method. She makes the following statements on the franchise value method:Statement 1: A higher asset turnover ratio increases the franchise P/E ratio, one of the components of the intrinsic P/E value.Statement 2: When firms pay out profits as dividends at a higher rate, a firm's intrinsic P/E value decreases.The lowest possible H-index concentration for the duopoly in the telecom sector identified in Mnoyan's research report is:
The Herfindahl index (H-index) provides an alternative way to measure industry concentration and is the sum of the squared market share of the firms in the industry. In a duopoly, two firms alone dominate the country's industry. Two firms of equal size would provide the lowest possible index level. The index level is then 2 x (0.50 = 0.50. The larger one of the firms is, the closer the index level approaches 1. (Study Session 11, LOS 36.c,d)
Tom Vadney, CFA, is president and CEO of Vadney Research and Advisors (VRA), a large equity research firm that specializes in providing international investment and advisory services to global portfolio managers. He has a staff of five junior analysts and three senior analysts covering industries and firms across the Americas, Europe, and Asia-Pacific regions.In a recent meeting with an institutional portfolio manager, Vadney is asked to review the differences between U.S. GAAP and International Financial Reporting Standards (IFRS) as well as provide a comprehensive industry analysis for the telecommunications sector in Europe and the Asia-Pacific region. Vadney asks Maria Mnoyan, a senior analyst covering the sector, to research the requested information for the client meeting.Prior to the meeting, Vadney and Mnoyan meet to prepare for the client presentation. They first discuss differences between U.S. GAAP and IFRS. Mnoyan states that although there will be increasing convergence between the two accounting standards, one major difference currently is that IFRS permits either the "partial goodwill" or "full goodwill" method to value the goodwill and the noncontrolling interest under the acquisition method. U.S. GAAP requires the full goodwill method. Vadney adds that U.S. GAAP requires equity method accounting for joint ventures, while under IFRS, proportionate consolidation is preferred, but the equity method is permitted.Vadney then asks Mnoyan to share her findings on the telecommunications sector. Mnoyan first presents an overview of the competitive forces that characterize the sector in the two regions. In particular, she notes that the sector in both regions is characterized by high switching costs. Vadney asks how high switching costs would affect the bargaining power of buyers and suppliers.Mnoyan firmly believes that investing in companies located in developing countries provides strong growth potential through technological change and increases in capital, labor, and savings that contribute to higher dividend levels, even if the dividend growth rate is unaffected.In her research report Mnoyan identifies several countries and industries with attractive investment potential. She notices that the telecommunications sector in one of the countries is characterized by a duopoly. The $50 billion telecom industry in another country in her analysis is dominated by h\e firms with market shares of $10 billion each.Finally, Vadney and Mnoyan discuss investment opportunities in specific firms. Mnoyan values firms using both the discounted cash flow model and the franchise value method. She makes the following statements on the franchise value method:Statement 1: A higher asset turnover ratio increases the franchise P/E ratio, one of the components of the intrinsic P/E value.Statement 2: When firms pay out profits as dividends at a higher rate, a firm's intrinsic P/E value decreases.Are Mnoyan's statements about the components of intrinsic P/E value correct?
Both statements are correct.The franchise value method breaks down a firm's intrinsic P/E value into two components, the tangible P/E value and the franchise P/E value:intrinsic P/E = tangible P/E + franchise P/E = (1 / r) + (FF x G)where:r = required return on equityFF = franchise factor. (1 / r) - (11 ROE)G = growth rate = g / (r - g) g = ROE x bROE can be rewritten as the DuPont equation. A higher asset turnover ratio (sales/ assets) increases ROE and increases both the franchise and the growth factors. Franchise P/E thus increases, resulting in a higher intrinsic P/E value for the firm. Statement 1 is therefore correct.When a firm pays our dividends at a higher rate, the retention ratio declines and the firm is reinvesting a smaller portion of profits in its business. The firm's growth rate will thus decline, leading to lower franchise P/E and intrinsic P/E values. Statement 2 is therefore also correct. (Study Session 11, LOS 36.e)
General Investments is considering the purchase of a significant stake in Pacific Computer Components (PCC). Although PCC has stable production output, the company is located in a developing country with an uncertain economic environment. Since the monetary environment is particularly worrisome. General has decided to approach the valuation of PCC from a free cash flow model using real growth rates. In real rate analysis, General uses a modified build-up method for calculating the required real return, specifically:required real return = country real rate + industry adjustment +company adjustmentElias Sando, CFA, an analyst with General, estimates the following information for PCC:Domestic inflation rate = 8.738% Nominal growth rate = 12.000% Real country return = 3.000% Industry adjustmen = 3.000% Company adjustment = 2.000%Additionally, Exhibit 1 reports information from PCC's financial statements for the year just ended (stated in LC).PCC generally maintains relatively constant proportions of equity and debt financing and is expected to do so going forward.Sando has gathered information on earnings before interest, taxes, depreciation, and amortization (EBITDA) and is contemplating its direct use in another cash flow approach aimed at valuing PCC. Consider the following two statements regarding EBITDA:Statement 1: EBITDA is not a good proxy for free cash flow to the firm (FCFF) because it does not incorporate the importance of the depreciation tax shield nor does it reflect the investment in working capital or in fixed capital.Statement 2: EBITDA is also a poor proxy for FCFE. Free cash flow to equity (FCFE) is closest to:
FCFE = NI + depreciation - FCInv - WCInv + net borrowing= 7.0 + 3.5 -3.2 -0.4 + (2.4 -2.0)= LC7.3 million, or LC7.300.000 (Study Session 12, LOS 41.c)
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