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CMA2 > 6.0 Valuation Methods /Cost of Capital > Flashcards

6.0 Valuation Methods /Cost of Capital Flashcards

1
Q

Constant Dividend Growth Model (single period)
Stock Valuation
Common Stock

A

Expected Dividend per share/
Discount Rate - Growth Rate

  • Expected Dividend= Last Dividend * (1 + Growth Rate)
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2
Q

Constant Dividend Growth Model (multiple years)

Stock Valuation

A

Last Dividend + (1 + (Growth percent) t power))/
Discount Rate - Growth

eg. 10 * (1.05)4th power = 12.16/
.12-.05

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3
Q

Variable Dividend (growth then stable) Stock Valuation

2 Stage/3 Steps

12% Return
5% Growth

A

End of Yr Dividend PV factor PV of Dividend
1 = 5.00 .893 4.47
2 5.00 * 1.05 = 6.00 .797 4.78
3 6.00 * 1.05 = 7.20 .712 5.13

sum 14.38

Step 2
calculate the present value based on steady growth (8%)
a. calculate the next dividend 7.20 * 1.08 = 7.78
b. use standard dividend growth formula
7.78/
.12-.08 = 194.50 x .712 (last pv factor) = 138.48

Step 3
sum the two : 14.38 + 138.48 = 152.86

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4
Q

Preferred Stock Valuation

A

Preferred Dividend Per Share/
Cost of Capital (Rs)

$12/
.15

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5
Q

Component Cost of Capital - Debt (Existing)

A

Effective Rate * (1-tax rate)

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6
Q

Component Cost of Capital - Preferred Stock (Existing)

A

Dividend Yield

Dividend /
Market Price

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7
Q

Component Cost of Capital - Common Stock (Existing)

A

Dividend Yield

Dividend/
Market Price

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8
Q

Component Cost of Retained Earnings

A

Normally lower than the cost of Common Stock due to no Issuance costs. (sometimes set equal without flotation costs. )

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9
Q

WACC

Weighted Average Cost of Capital

A

Is based on the MARKET value, not BOOK

  1. Calculate each Component Cost
  2. Calculate each components weight based on Market Value

Component Percent x Component Costs = Value
10% (Debt) 7.41% .741 %
20.91% (Preferred) 11.5% 2.404%
63.64% (Common) 16.00% 10.1824%
1.45% (Retained Earnings) 16.00% .872%

SUM = WACC 14.20%

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10
Q

WACC formula with no preferred stock

A

Equity/ x Rs Equity x Debt/ x Rd (1 - Tax Rate)
Total Total

Rs = Cost of Equity
Rd = Cost of Debt
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11
Q

Effect of Taxes

Capital Gains
Dividends
Interest on Debt

A

Capital Gains

a. Corporate received Capital Gains=Normal Tax Rate
b. Individual received Capital Gains = 16%

Dividends Received

a. Corp to Corp = 70%-100% tax free
b. Corp to Individual = normal tax rate

Interest on Debt

a. Corp to Individual = Tax Deductible (so Corp prefers debt to Debt
b. Corp to Individual CAPITAL GAINS = INDIVIDUAL investor prefers to CAPITAL GAIN because partially non taxable (This is not debt to dividends but Interest to capital gains

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12
Q

MCC - Marginal Cost of Capital

A

The cost of NEW capital = the WEIGHTED Average of the NEXT dollar. Not the cost of the specific component

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13
Q

Cost of NEW Debt

A

Annual Interest Expense/

Net Proceeds

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14
Q

Cost of NEW Preferred Stock

A

Next Dividend/

Net Proceeds

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15
Q

Cost of NEW Common Stock

Cost of NEW Retained Earnings

A

Next Dividend/
Net Proceeds + Growth Rate

$8/
$55-3 + 2%

Retained Earnings does not include the $3 Flotation cost

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16
Q

WACC of New Capital

A

Same as WACC for existing except percentages can be
using the same weight if the company has achieved optimal x each components cost. Or can be adjusted such as using retained earnings first

17
Q

Long COLLERUP

A

A long position: the investor hopes to gain with a rise in price in the future

18
Q

Cash Flow Hedge

A

A hedge were intent is to protect future cash flows

19
Q

SHORT HEDGE

A

person Borrows and then Sells NOW. Then replaces the stock borrowed with lower priced stock later (hopefully)

20
Q

FAIR VALUE HEDGE

A

Hedges against the change in Fair Value

21
Q

NATURAL HEDGE

A

Does not rely on sophisticated financial instruments

ie financing a piece of equipment over its natural life

22
Q 
Exercise Price  (Strike Price)
Option Price (Option Premium)
A

Exercise or Strike Price is the price at which the Option can be acted on

Option Price (Option Premium) the thing that you buy at the specified price for the RIGHT to exercise the option.

23
Q

Covered Option v

Naked Option

A

Covered: The SELLER has possession of the underlying
Naked: The SELLER does not yet own the underlying which they may have to perform on

24
Q

Types of Options

A

Stock Option: Underlying is a traded stock
Index Option: Underlying is an INDEX. Settlement in Cash delivering underlying is impossible.
LEAPS (Long Term Index Option): up to three years away
Foreign Currency Options: Right to buy a specific currency at a designated EXCHANGE RATE

25
Q

Call Option

A

Right to Buy (Call) at a specific price
Intrinsic Value is : Price of Underlying LESS Exercise Price

Out of the Money: Underlying is less than the Exercise Price
In the Money: Underlying exceeds the Exercise Price
At The Money: Underlying equals the Exercise Price

26
Q

Call Option Gain/Loss Calculation

A

In The Money
Buyer:
(Underlying over Exercise Price) - Option Price) x Units
Seller
Option Price - (Underlying over Exercise Price) x Units

Out of The Money
Since nothing will be exercised>
Buyer > Option Price paid is the loss
Seller > Option Price received is the gain

27
Q

Put Option

A

Right to SELL at a fixed price (Right to Put on the Market)
Intrinsic Value = Exercise Price less the value of underlying

In the Money: Price of underlying is less than exercise
Out of the Money: Price is higher than exercise price
At The Money: Price is at the exercise price

28
Q

Put Option

A

Right to SELL at a fixed price (Right to Put on the Market) . A SHORT position.
Intrinsic Value = Exercise Price less the value of underlying

In the Money: Price of underlying is less than exercise
Out of the Money: Price is higher than exercise price
At The Money: Price is at the exercise price

29
Q

Put Option Gain/Loss Calculation

A

In The Money:
Buyer
Exercise over Underlying - Option Price x Units
Seller
Option Price - Exercise Price over Underlying x Units

Out of the Money:
Buyer
Option Price Paid
Seller
Option Price Received
30
Q

Put Call Parity Theorem

A

Value of Call + PV of exercise =
Value of Put + Value of Underlying

PV of exercise is at Rf rate

Restated:
PV of Exercise = Value of Put + Value of Underlying - Value of Call

ie Value of buying a Put + Value of Underlying - Buying a Call = PV of Exercise at risk free rate

31
Q

Valuing an Option

What happens when underlying changes, exercise changes, Interest rates Change

Volitility, Term

A

Exercise Price:
INCREASE in exercise of a Call, reduces the value
DECREASE in the exercise of a Put, reduces the value

Price of Underlying:
Call underlying increase = Increase in Call Value
Put Underlying decreases = Increase in Put Value

Interest Rates:
In Inflation, using inflated dollar to pay, thus to pay a Call using inflated dollar so value increase. Put decreases because you are paying the decrease with inflated dollar.

Time to Maturity: Increase Call and Put
Volatility: Increases Call and Put

32
Q

Forward Contract

A

A simple hedge: Buyer is locking future delivery at specific price; Buyer is long because he is guarding against higher future. Seller is Short because guarding against lower future.

Different than option because buyer and seller MUST deliver. It is not an option to be exercised

33
Q

Futures Contract

A

Rather than specific things to be delivered as in Forward Contract> Undifferentiated Commodities: Currency, Grain
To be delivered in a Month (not a day)

Also, profit or loss is marked daily and settled. Less risk of default

Also Forward delivers actual product. Futures only deliver difference between prices.

34
Q

Swaps

A

Interest Rate Swaps:
Firm exchanges payments at one interest rate for another that matches better

Currency Swaps:
Company A need Euros, Company B need USD.
Agree to exchange at a specific rate

Credit Default Swaps: One bank basically insures against to non-pmt to a second bank buy a third party

most swaps are at the money. As interest, exchange rates and credit risks change the swap changes

CMA2 (30 decks)

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