Equity Flashcards
marketability
the ease with which the securities can be sold
seasoning
the degree of familiarity of the public with the company and the issue
Value of equity =
value of operating asset + value of non-operating asset - value of debt
retention ratio
the fraction of earnings a firm retains for investment
payout ratio
the fraction of earnings a firm pay out
reinvestment rate of return (RIR)
the rate of return equity holders get on new investment
If the firm only pay out dividends, what is the payout ratio formula
DIV= (1-b)*EPS
DIV= Dividend at 1-Year
b = Retention Ratio
EPS= Earnings per Share at 1-Year
formula for growth rate
g = b* (RIR)
g = Growth Rate
b = Retention Ratio
RIR = Reinvestmant Rate of Return
Use the Gordon growth model formula to compute the price of a stock that will pay a $5 dividend per share next year and the dividend is expected to stay at $5 forever. Assume 5% cost of equity. The price of the stock today is $______
Price = DIV/ (r -g) = 5/(0.05-0) = $100
DIV= Contant Dividends or Cashflows
r = cost of equity
g= growth rate
Firm A pays out 20% of its earnings as dividends and Firm B pays out 30% of its earnings as dividends. Both firms have the same return on investment. Which firm has higher growth rate?
The higher ratio of DIV/EPS -> The smaller retention ratio (b) -> The smaller growth rate
Ans: Firm A (20% as the DIV/EPS ratio vs 30%)
Hint: Intuitive theoretically, the more retain earnings should provide higher growth rate
T or F: Stocks payouts (dividends) are made before corporation tax has been deducted.
F.
they are made after corporation tax deducted
DCF Model
value of equity = value of assets or PV - value of debt
what is the advantage of DCF model?
DCF model focuses our attention on the operating side of the business. Thus, we don’t need to worry about how firm plans to pay its debt over time.
T or F: We don’t take into account the future debts for our DCF model
True
Free Cash Flow (FCF)
The cash flows generated by the firm’s operations after all required investments are funded.
T or F: FCF is the cash flow available after debt is paid
F
its the cash flow available to be paid to debt and equity holders
FCF Formula
FCF = NOP − ∆netPPE − ∆NOWC
- NOP: Net Operating Profit
- netPPE: Net Property, Plant, and Equipment
- NOWC: Net Operating Working Capital
Net Operating Profit (NOP)
The profits available for equity and the holders after taxes are taken away, but before investment is taken into account or:
EBIT - Taxes*EBIT
FCF’s taxes =
t* EBIT
t = tax rate
EBIT = earnings before interest and taxes
True taxes
= t* (EBIT - interest)
interest tax shield
= t* interest
∆netPPE
= netPPE (t) - netPPE (t-1)
or = Capex - Depreciation
t= time period
Capex = Capital Expenditures
Net Operating Working Capital (NOWC)
= OCA - OCL
OCA: Operating Current Assets
OCL: Operating current liabilities
what are examples of operating current assets?
account receivables, inventories, pre-paid expenses…..
what are examples of non operating current assets?
cash, marketable securities…
what are examples of operating current liabilities?
accounts payable, accrued expenses, accrued wages, deferred revenues,….
T or F: Short-term debt is operating current liability
F - short-term debt is a non operating current liability
Suppose firm HHKB is able to reduce the interest it pays on its debt from 5% to 4.5%. How will this affect HHKB’s net operating profit?
It doesn’t change
If a company buy a machine worth of $1mil, how much does netPPE goes up?
$1mil because the machine is a new Capex
FCF Formula with Capex
FCF = NOP - Capex + Depreciation -∆NOWC
T or F: What part of FCF Formula, EBIT is part of?
Net operating profit (NOP)
T or F: Non operating profit is technically EBIT subtract taxes owed
True
EBIT =
Sales - COGS - Operating Expenses
Last year, firm LOL Darius‘s net PPE is 2M dollars. This year, LOL Darius’s capex is 3M dollars and has depreciation of 1M dollars. Calculate the change in net PPE this year.
change in net PPE = capex - depreciation = 3 -1 = 2
The firm Latea’s net operating working capital last year was 2M dollars. This year’s net operating working capital is 3M dollars. How would this affect the FCF calculation this year?
FCF Decrease $1M this year
∆NOWC
the difference of net operating working capital (NOWC) between this year and the prior
1) Gross Profit =
2) Gross Profit Margin
1) Sales - COGS
2) The ratio of Gross Profit to Sales = 100% (Sale) - COGS/Sales
Operating Profit Margin
EBIT/ Sales or
Gross Profit Margin - (Operating Expenses/Sales)
Fix asset turnover ratio
What does it measure?
sales/netPPE
how effectively a firm uses it assets
T or F: A higher number of sales/PPE indicates lower sales generated per dollar of fix assets
F- the opposite
accounts receivable days on hand
account receivable/ daily sales
daily sales = sales/365
inventories days on hand
inventories/ daily COGS
daily COGS= COGS/365
inventories (t+1) =
= inventories (t) + purchases - COGS
inventories (t+1): final inventory in a period
inventories (t): inventory at the beginning of a period
accounts payable days on hand
account payable/ daily purchases
daily purchases = purchases/ 365
Why is it hard to forecast FCF? because it’s hard to estimate:
Operating policy and performance:
1) sales, including how long will customer pay the firm back (account receivables)
2) expenses, including firm purchases & type of credit (account payable)
Level of fix assets: firm investment policy
What some key metrics that we can use to find out the competitiveness among companies, industries, etc…?
1) COGS/Sale
T or F: We can use growth rate projection from sales (given by executives) to determine the COGS value
F: In real world, COGS value doesn’t change accordingly to change in sale revenue. To have an accurate picture, we should use historical data of COGS/Sales
Suppose the firm is in a very competitive environment and the COGS/Sales has been increasing over time, for example: 60%, 70%, 80% in past three consecutive years. If the competition will be as fierce as the last year, what is your projected COGS/Sale?
80%
Why do we not subtract interest payment in the NOP formula?
Because NOP represents the profit to both shareholders and debtholders of the firm
According to economists, increase returns to scale implies….
that high fix asset turnover ratio: Sales/netPPE
Suppose in each of the past three years, ARDOH has been 30 days. Currently, other competitors are giving customers 45 days to pay and the CEO of the firm intends to follow the competitors’ strategy. What is a most reasonable projection of ARDOH for the next few years?
45 days
T or F: The multiple EV/EBIT is more suitable than EV/Sales when comparing similar firms with different profit margins.
True
What are some financial ratio that can be used from historical data average estimate?
1) Operating Expense/Sales
