Cost of Equity Flashcards

1
Q

What do shareholders expect for a dividend be paid?

A

At least once at the end of the year

Continuous growth

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2
Q

What if expected return is not achieved by the firm?

A

Share price falls which damages shareholder’s wealth

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3
Q

Weaknesses in dividend growth model?

A

Dividends are paid
Company has share price
Dividend growth is estimated and is constant

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4
Q

What is meant by cum div?

A

Dividend is about to be paid

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5
Q

When should the share price need to be adjusted?

A

By stripping the dividend out of the share price to create an ex-div price

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6
Q

Why is the ex-div price needed?

A

As shareholders real investment is not cum div price if they get a dividend

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7
Q

If the share price is ex-div?

A

There is no imminent dividend and therefore the adjustment does not need to be made

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8
Q

Methods of estimating future dividend growth?

A

Using historic growth

Using current reinvestment levels

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9
Q

What is another method of calculating cost of equity?

A

CAPM

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10
Q

Assumption of CAPM?

A

Investors diversify their investments across a wide portfolio to reduce risk

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11
Q

Number of investments = less risk?

A

yes

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12
Q

What is unsystematic risk?

A

Component of risk associated with investing in a particular company

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13
Q

What is systematic risk?

A

Component of risk that still remains even of a diverisifed portfolio is created

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14
Q

What is a diverisifed investor only concerned with?

A

Systematic risk

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15
Q

Why is beta factor important?

A

As some firm’s shares are more sensitive to market downturns than others are

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16
Q

Beta < 1?

A

Below average risk. Returns expected by shareholder less than market average

17
Q

Beta = 1?

A

Moves in line with market. Returns expected by shareholder equal to market average

18
Q

Beta > 1?

A

Above average risk. Returns expected by shareholder are greater than market average

19
Q

What is the difference between expected average market return and risk-free return?

A

Market or equity risk premium

20
Q

What is a risk-free investment?

A

Treasury bills

21
Q

Drawbacks of CAPM

A

Single period model
Estimating beta factor
Size of company
Assumes diversified portfolio

22
Q

Why is a single period model a disadvantage?

A

Does not adjust for different planning horizons

23
Q

Why is estimating the beta factor a disadvantage?

A

Historic and does not give accurate measure of risk

24
Q

Why is size of company a disadvantage?

A

Small companies

25
What happens with shares with book values that are close to their market values?
More likely to fail
26
Why is CAPM greater tha dividend growth model?
It does not rely on potentially inaccurate estimates of future dividend growth rate