Equity Valuation & Inv Appraisal & Real Options & Cap 1 & Cap 2

Question 1

Gordon Growth (constant G)

Answer 1

P = D_O(1+G)/(R-G)

Question 2

What is G equal to

Answer 2

G = b(ROI)

Question 3

Growth vs Income Stocks

Answer 3

Growth -> Investors care about future earnings growth not next period dividend
Income -> next period divided

Question 4

When will PVGO be +

Answer 4

When ROI > cost of equity, PVGO will be +

Question 5

When will you use valuation based on comparable firms?

Answer 5

When after a point growth of the company indefinitely = avg stock growth in the economy + p/e ratio is the same

Question 6

P/E ratios expected indicator of what?

Answer 6

E Growth opportunities

Question 7

P/E ratios increase with what

Answer 7

Increase with b, given ROI>R

Increase with ROI

Question 8

In doing NPV analysis which cash flows do you consider?

Answer 8

Incremental cash flows

Question 9

How do you calculating net cash flows

Answer 9

op cf - capex- opp cost - delta WC - taxes on profits

Question 10

what is opportunity cost

Answer 10

cost of foregoing opportunity to use asset elsewhere. assets which are owned by the firm can be sold or let

Question 11

Are investment costs tax deductible at origin?

Answer 11

No they are not, tax authorities use Capital allowances to reduce tax burden

Question 12

impact on after tax incremental cash flows due to corp tax?

Answer 12

Op(1-Tc) + TcxCA

Question 13

what do you pay taxes on?

Answer 13

operating profits

Question 14

What is the formula for written down value?

Answer 14

WDVn = WDVn-1 - CA + Inv Cost - Sales Proceeds

Question 15

Final CA is known as?

Answer 15

Balancing capital allowance

Question 16

Formula for balancing CA?

Answer 16

Bal CA = WDVn-1 - Sales Proceeds

Question 17

what is final WDV?

Answer 17

0

Question 18

What is R ( OCC)

Answer 18

R is the minium required rate of return to take on the project. this R would be the same of investing that amount of money in a well diversified portfolio of financial assets with the same level of systematic risk

Question 19

what do use to d dividends?

Answer 19

CAPM

Question 20

what do use to use to discount interest payments or principal repayments?

Answer 20

CAPM but debt where Rd = Rf

Question 21

What is firms R

Answer 21

r = WACC

Question 22

WACC equals to what?

Answer 22

R on assets WACC = RA

Question 23

Pre tax WACC, Post Tax WACC

Answer 23

Pre tax WACC = RA, Post Tax WACC < RA

Question 24

When does a firm use own WACC = Ra to discount its project?

Answer 24

When firm and project have the same level of systematic risk AND d/e ratio remains constant at the target

Question 25

what does asset beta represent?

Answer 25

operating risk of the company

Question 26

what does equity beta represent

Answer 26

represents the financial risk of the company w having debt on the ball sheet

Question 27

when do you use method of similars, describe

Answer 27

say the ans

Question 28

difference between american call option and european call option

Answer 28

american - exercise anytime within the next year, European - exercise in the next year

Question 29

what is pi*

Answer 29

pi * is the risk neutral probability of an upjump (1-pi*)..

Question 30

E(total return on project) - options

Answer 30

risk free rate of return

Question 31

real options do what to value of firm?

Answer 31

increase value

Question 32

growth options increase what BV or MV

Answer 32

Growth options increase MV of firms not BV

Question 33

What does MM1 say

Answer 33

firm value is independent of capital structure choice, value depends on on net operating income or FCF

Question 34

What does that imply (MM1)

Answer 34

investing and financing decsisions are seperate

Question 35

We know that MM1 holds, is WACC of R_L = WACC of R_U

Answer 35

Yes, under MM1 WACC between the two remains the SAME.

Question 36

Is the cost of equity going to be higher for a leverd firm under MM1? (hint MM2)

Answer 36

Yes, it increases linearly with an increase in D/E (MM2) | R_E = R_A + D/E(R_A-R_D)

Question 37

Under PCM of MM (1958) assumptions what all remain the same

Answer 37

WACC and R_D remain the same GIVEN R_D is riskless. R_E increasing linearly with leverage (MM2) under MM (1958) assumptions.

Question 38

How do we model risky debt? | assumption of risky debt?

Answer 38

We use real options on firms equity (already risky) and now firms debt Assumption - zero coupon

Question 39

How do we model firms equity as an option, specify strike price (MM 1953)

Answer 39

Equity is a long call option with strike equal to FV of debt and expiry as maturity date of firms debt

Question 40

How do we model firms risky debt?

Answer 40

Long a riskless bond + short the value of debt. K = F Maturity = maturity of firms debt

Question 41

What is the put call parity under MM1?

Answer 41

C + PV(F) = V + P

Question 42

What is EAC, equalised annual cost and how is it calculated?

Answer 42

EAC = PV/Annuity factor used to calc present value

Question 43

Under MM2 what assumption do we break?

Answer 43

PCM - taxes. Taxes create a tax shield which create a wedge between V_L and V_U

Question 44

What is the PV(TS)

Answer 44

PV(TS) = TcxD

Question 45

If debt is perpertual what is the V_L

Answer 45

V_L = V_u + PV(TS)

Question 46

What happens to WACC when you have taxes?

Answer 46

WACC would decrease as WACC = R_A(1-tc(D_l/V_l))

Question 47

When do we use WACC over APV

Answer 47

When D/E ratio at the target remains constant or very close to the target

Question 48

Which companies should have more debt?

Answer 48

Higher profitability companies should have more debt. Companies with higher NTDS should have lower debt

Question 49

With personal taxes what is the value of my firm?

Answer 49

V_L = V_U + gD | Without V_L = V_u + TcxD

Question 50

What is the relationship between PV(BS) and PV(TS)

Answer 50

it is a 1-1 increase

Question 51

what is the static trade off theory

Answer 51

there is a trade off for having debt vs having more of it due to COFD. This means cost of capital depends on capital structure

Question 52

What can static trade off theory not explain?

Answer 52

why leverage is negatively related to profitability and statistically negative abnormal returns when firms issues equity