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Adjusted R^2 adjusts for:

the loss of degrees of freedom when additional independents variables are added to a regression.

If the (Engle-Granger) Dickey-Fuller test rejects the null hypothesis that the error term has a unit root then the conclusion is:

that the error term in the regression is covariance stationary. Therefore the two time series are cointegrated.

The parameters and standard errors from linear regression will be consistent and will allow testing of the hypotheses about the long-term relationships between the two series.

 

Major differences between assumptions for the Structural Model and Reduced Form Model?

Structural Model Reduced Form Model
  • Balance sheet is simple with only one class of zero coupon bond.
  • Asset is actively traded in the market.
  • Risk-free rate is constant.
  • There is a zero coupon bond traded in the market.
  • Risk-free rate is stochastic.
  • Default risk depends on the economic conditions.

ROCE is essentially ROIC before…

TAX

and is defined as operating profit divided by capital employed

ROCE is useful when comparing peer companies in different countries because the comparison of underlying profitability would not be skewed by low taxes.

Capitalization Rate (formula)

Capitalization Rate = WACC – Long term Growth Rate

Does CAPM incorporate company specific risk?

No

A possible drawback to EV/EBITDA is?

EBITDA overestimates cashflow from operations if the company’s working capital is growing.

Lack of Control Discount (formula)

Lack of Control Discount = 1 – (1 / (1 + control premium))

Remember: Discounts are usually multiplicative rather than additive.

The Yardini Model (formula)

CEY = CBY – b x LTEG + Residual

CEY = current earnings yield

CBY = Moody’s A-rated corporate bond yield

LTEG = consensus five-year earnings growth

b = coefficient measures the weight the market gives to five-year earnings projections

Justified P/E = 1 / CBY – b * LTEG

Criticisms of the Fed Model

  1. It does not consider an equity risk premium.
  2. It ignores the portion of equity value that comes from long-term earnings growth.
  3. It compares a real variable (index yield) to nominal variable (government bond yield) which makes it unhelpful when inflation is either non-existent or very high.