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FTIP: Investment Analysis and Valuation

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Investment Analysis and Valuation

Investment Analysis and Valuation tests whether you can convert forecasts into a defensible value and explain the drivers. Expect discounted cash flow (DCF), relative valuation, bond pricing and duration, cost of capital, and the difference between enterprise and equity value. The exam rewards consistency between the cash flow, the discount rate, and the claim being valued.

Core rules and concepts

  • DCF: value = sum of CF_t/(1+r)^t plus terminal value/(1+r)^n. Match cash flow to discount rate: FCFF with WACC gives enterprise value; FCFE with cost of equity gives equity value.
  • Terminal value: Gordon growth TV_n = FCFF_{n+1}/(WACC - g). g must be below long-run nominal GDP growth and below WACC.
  • Relative valuation: P/E, EV/EBITDA, P/B, and yield multiples are only comparable if growth, risk, capital structure, and accounting are similar.
  • Bond valuation: price is the present value of coupons and principal at the yield to maturity. Price and yield move inversely; longer duration and lower coupons mean greater price sensitivity.
  • Cost of capital: WACC = (E/V) x r_e + (D/V) x r_d x (1 - tax rate). Use market values and after-tax cost of debt.
  • Accounting adjustments: capitalize leases or normalize one-off items when they distort comparability; check diluted shares.

Worked example

A company is forecast to generate FCFF of $100 million next year. WACC is 10% and stable growth is 3%. Terminal value at the end of year 1 = 100/(0.10 - 0.03) = $1,428.6 million. If this is a standard one-stage DCF, enterprise value today is also $1,428.6 million because the $100 million is next year's cash flow. Equity value = EV - net debt. If net debt is $300 million, equity value = $1,128.6 million. With 50 million diluted shares, value per share = $22.57. If an analyst used 4% growth instead, TV would be 100/(0.10 - 0.04) = $1,666.7 million, a 16.7% increase from a one-point growth change, showing terminal-growth sensitivity.

Traps that cost marks

Do not discount FCFF at cost of equity or FCFE at WACC. Do not add cash to enterprise value to get equity value; subtract net debt. Do not compare P/E ratios across different capital structures without care. Do not let terminal growth exceed the discount rate. Do not use trailing earnings with a forward multiple without adjusting numerator and denominator consistently.