Question

In: Finance

Explain, using examples, the difference between a ‘top-down’ approach and a ‘bottom-up’ approach to equity valuation....

Explain, using examples, the difference between a ‘top-down’ approach and a ‘bottom-up’ approach to equity valuation.

b) There are four principles that underlie the concept of efficient markets. Outline, using examples, each principle.

c) You are considering investing in a project whose cash flows are given below:

dISCOUNT RATE	5%

Year
0	-800
1	200
2	250
3	-200
4	300
5	450

i. Calculate the present value (PV) of the future cash flows of the project ii. Calculate the net present value (NPV). Should you undertake the project?

Expert Solution

a) Top down and Bottom-up investing vastly different ways to analyse and invest in stock.However both approaches have the same goal to identify great stock.

1.Top down aproach focuses on the "big picuture" on overall economy and macroeconomic factors and performance of sectors or Industries.

Bottom up investing approach focus less on market conditions,macro economic and industry fundamentals.

2. Top down investment analysis includes Economic growth or GDP(Gross domestic product),monetary policy and Bond rice and yields.

Bottom up analysis includes financial ratio,earnings,revenue,cashflow and free flows and management leadership and performance.

b) There are three common forms in which efficient market -

Weak form efficiency - Future price can not be predicted by analysing prices from the past.Excess return can not be earned in the long run by using investment strategies based on historical data.

Semi strong form efficiency - Share price adjust to publcly available new information,no excess returns can be earned by trading on that information.

Strong form efficiency - Share prices reflect all information,public& private and no one can earn excess return,a market needs exist where investor can not consistently earn excess return over a longer period.

c) Calculation of present value future cashflows

Total cashflows = 200

Discount rate 5% for 5 years = 4.3294

PV of cash flows = 2004.3294

= 865.88

Note:There is no information investment(cash outflow) for calculation of NPV.

jeff jeffy answered 2 years ago

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