Chapter 5 Flashcards

1
Q

Market value of any investment

A

Expected returns discounted at investors required rate of return

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Ke (dividends constant)

A

D0/P0

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

P0

A

Price ex dividend

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

KE with dividend growth at g

A

ke = D0(1+g)/P0 + g

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Dividend valuation model flaws

A
  • g must be less than ke, if equal, share price becomes infinitely high. growth rate to perpetuity this high impossible
  • In practice growth rates vary
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

During the period after announcement of dividend but before payment, prices…

A

Rise in anticipation of payment - share is cum div

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

When does a share go ‘ex-div’

A

Shortly before paid, anyone acquire afterwards will not receive the dividend

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

g can be calculated using which function

A

POWER

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Input to power function

A

Most recent div/oldest dividend, 1/time period of growth

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Garden growth model - g is calculated by

A

r * b
r = current accounting rate of return
b = proportion of profits retains

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

Accounting rate of return

A

profit after tax as percentage of opening capital employed (opening balance sheet values)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

Issues with garden growth model

A

relies on accounting profits
assumes r and b are constants
inflation can distort accounting rate of return
assumes all new finance from equity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

Issues with dividend valuation model - underlying assumptions

A

Assumes shares have value because of dividends - high tax rate investors likely prefer capital gains
Assumes dividends either don’t grow or grow constantly
Estimates of future dividends based on historical data - ignores future market conditions, investor confidence, economic conditions

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Issues with dividend valuation model - data used

A

Share price is used, these can change daily and are not always rationally or efficiently

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Issues with dividend valuation model - growth in future dividends

A

More likely linked to growth in earnings than to past dividends, but earnings do not feature?

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Impact of a bonus issue on DVM estimate g

A

No cash - go back and adjust number of shares for bonus issue

17
Q

Impact of rights issue on DVM estimate g

A

No adjustment necessary, as inflow of funds

18
Q

Cost of equity - CAPM

A

ke = rf + 𝝱(rm-rf)

19
Q

Estimating 𝝱 factors

A

Examine 𝝱 of quoted companies in similar business
however often other firms engaged in several lines of business, different gearing etc.

20
Q

Cost of preference shares

A

Dividend / ex-div market value

21
Q

Cost of debt (irredeemable/current market price=redemption price)

A

annual interest (starting 1y)/market price

22
Q

Cost of debt redeemable at not current market price spreadsheet formula

23
Q

RATE inputs

A

number of period
amount of interest paid in a period
(PV) of asset - market price
Future value

24
Q

Gross redemption yield < couponrate

A

bonds issued at premium

25
Gross redemption yield > coupon rate
bonds issued at discount
26
Gross redepmtion yield = coupon
bonds issued at par
27
KD with tax
Interest * (1-T)/P0
28
Steps in determining convertible debentures
1. calculate value of conversion option 2. Compare conversion option with cash option choose higher 3. use RATE to calculate pre tax YTM for redeemable No tax effect
29
Calculating weights for WACC wherever possible should be based on
Market weights - mv for debt and equity
30
Assumptions to use WACC
- Historical debt/equity is not going to change - Systematic business risk of the firm will not change - Finance is not project specific
31
Problems with WACC
- Knowing which sources of finance to include (ST loans?) - Loans without market value (take book value) - Cost of capital for small companies - hard if unquoted and lack of liquidity from securities and being smaller makes more expensive to finance, also no share price