Chapter 1

Question 1

Limitations of the Dividend model

1. Po

Ke = Do(1+g)/Po + g

Po = (1) +(4)
Do = (2)
g = (3)

Answer 1

1. Shares have value bcs of the dividend - not always TRUE
   * some firms have a deliberate policy of no or low dividend payouts
   * would render any valuation using the methodology rather unrealistic

Question 2

Limitations of the Dividend model

2 Do

Ke = Do(1+g)/Po + g

Po = (1) +(4)
Do = (2)
g = (3)

Answer 2

2. Dividends do not grow or grow at a constant rate
   * may be realistic in the long term it can be subject to short-term fluctuations which undermine calculations of the cost of equity

Question 3

Limitations of the Dividend model

3 - g

Ke = Do(1+g)/Po + g

Po = (1) +(4)
Do = (2)
g = (3)

Answer 3

3. Estimates of dividend growth rate
   * tend to be on historic patterns rather than the actual
   * the firm is likely future earnings, consideration - might produce more meaningful cost of equity calculations

Question 4

Limitations of the Dividend model

4 - Po

Ke = Do(1+g)/Po + g

Po = (1) +(4)
Do = (2)
g = (3)

Answer 4

4.Share prices are constant

Question 5

Systematic and unsystematic risk

What is systematic risk?

Answer 5

1. Also known as non-diversifiable, non-specific, unavoidable or market risk
2. type of risk that all companied exposed no matter sector they operate in
3. Cannot be eliminated through diversification
4. Eg: interest rate changes, recession (biz cycle), oil price change, wars , gov policy

Question 6

Systematic and unsystematic risk

What is unsystematic risk?

Answer 6

1. Also known as diversifiable, specific avoidable or non-market risk
2. type of risk that affect a aprticular market sector or individual company
3. Can be diversified away by investing in a portfolio of 15-20 randomly selected securities
4. Eg: chairman resigning, strikes by the employees, change in regulations that affects a particular market sector