Discussion Areas Flashcards
Dividend Policies
BS CAT MD
Signalling - change may send out signal to the market
Clientele Effect - change in policy may cause investors to sell shares
Bird in the hand/Traditional theory - prefer dividends now than capital gains later
Tax Effect - some shareholders prefer dividends to capital gains for tax purposes
Agency problem - shareholders don’t want something to happen but have no say
M&M - shareholder wealth not increased by paying dividends, increased by positive npv investments
DIY Dividends - shareholders can sell shares if needed
Real options - definition and examples
Project value due to flexibility not accounted for in the DCF:
Follow on - new products
Abandonment - ability to abandon
Timing - one project beginning now, another beginning later
Growth - start small and then grow investment later
Flexibility - option to be flexible (eg manufacturing overseas)
Shareholder Value Analysis
SLOWCAT
Sales growth rate
Length of projects (increased is good)
Operating margins
Working capital
Cost of Capital
Asset investment
Tax
Predictive vs Prescriptive Analytics
Predictive - linear regression, simulation, correlation
Predictive use historical and current data to create predictions about the future
Prescriptive - optimal outcome using predictions/AI
Prescriptive combine statistical tools with AI and algos to calculate optimal outcome
Hedging methods advantages and disadvantages
Forward:
Specifically tailored, avoids downside risk
No secondary market
Future:
Easily tradable, no counterparty risk, cheaper
Imperfect hedge due to standardisation
Money market:
Complex to implement
Might use up lines of credit
Options:
Allows exploitation of upside, no downside risk
No secondary market
Premiums can be expensive
Explain/identify risk of trading overseas (not forex)
Political - political actions restricting market
Cultural - product not compatible with overseas culture
Physical - lost/stolen/damaged in transit
Credit - customer default risk
Trade - cancellation of order in transit
Liquidity - unable to finance credit given to customers
Taxes - increased taxation
Remittance - restrictions on remittances
Market price of a bond?
=PV(discount rate, nper, interest, redemption value)
Yield of redeemable debt?
=RATE(nper, interest, -market price, redemption value)
Factor to multiply by for interest rate options
£500,000 x 3/12
125,000
Financing written parts considerations
Financial risk - debt = more risk
Analysis and discussion - numbers
Theory
Practical gearing
Ratios
Industry averages
Control
Exit routes
Security
Cost/Cash flows
Sensitivity analysis formula
Total NPV / NPV of CFs affected
Capital rationing
Hard
External capital markets limit supply of funds
Soft
Firm imposes own internal constraints
Assumptions when using WACC as discount rate
- Constant gearing (if not use APV)
- Constant systematic business risk (if not use CAPM)
- Finance is not project specific
APV
1) Ungeared ke to calculate base case value (use ungeared ke as discount for npv)
2) PV of tax shield arising from extra debt
3) Less issue costs
Why do you need APV
Because financing will change the gearing of the firm therefore changing the WACC
Earnings multiples and company valuations
Earnings waterfall:
PBIT
- less interest
PBT
- less tax
Earnings/Profit
- less dividends
Earnings retained
P/E ratio * Earnings
ER Methodology ->
EV = market cap (MV of equity) + pref shares + minority interest + debt - cash
Pros and Cons - Asset based valuation
Asset based:
Pro - Assets more certain than predicted income
Con - intangibles not included balance sheet (people etc) left out
Pros and Cons - Dividend based valuation
Pro - Good for minority interest, no dividend policy control
Pro - Easy
Con - Estimating
Con - Finding similar listed companies
Con - Ke estimate
Con - Private company discount
Pros and Cons - Earnings based valuation
Pro - Good for controlling interest, can extract all the earnings out of a company
Con - Earnings can be erratic
Con - Accounting policies could manipulate earnings figures
Con - Finding similar listed companies
Con - Private company discount
Levels of efficient markets
Strong:
All information reflected in share price (even secret)
Impossible to beat market
Information affects shares price as soon as it exists
Semi strong:
All publicly available information reflected in share price
Beat market using inside information
Information affects shares price when published
Weak:
Past share price movement information incorporated
Not by using trends - use secret and published information
Information slow to affect share price
Prescriptive analytics - pros and cons
Advantages
- able to identify optimum investment decisions
- consider impact of multiple decisions and variables
Limitations
- complex to create
- requires specialist data science skills
- reliability depends on reliability of inputs
Gordon growth model formula
g = r x b
r - ARR % on new investment
b - earnings retention %
ARR:
earnings for the year
/
(opening capital (opening re) + share capital)
Cost of equity for an acquisition
Use targets asset beta with acquirers gearing ratio
Intrinsic value of an option
current price - exercise price
Time value of an option
option premium - intrinsic value
Intrinsic value is affect by
market price
exercise price
(components of formula)
Time value affected by
Volatility (increase = increase)
Interest rates
Time to expiry
Which option/future would an interest rate borrower need
Put option
Sell future contracts
How to settle futures contract?
Calculate profit or loss on contracts
Change PRINCIPAL + PROFIT OR LOSS at future SPOT RATE
Interest rate parity theory and equation
Risk free gains are not possible if rate are out of alignment.
Exchange rates move in directions to compensate for interest rate/inflation differences.
ave spot * (1 + ave o/s)/(1 + ave uk)
don’t forget to apportion rates!
Why is a hedge not 100% effective?
Basis risk - futures price not exact same as the underlying product
Contracts rounded
Economic risk
Economic risk is the variation in the value of the business (i.e. the present value of future cash flows) due to unexpected changes in exchange rates.
Formula for a perpetuity
CF * ( 1 / r )
growing:
CF * ( 1/ r -g )
