Lecture 3

Question 1

what is the normal P/B then what is the return that the firm will earn on its book value

If the firm has a normal P/B what is the expected residual earning

What is the implication of the firm has P/B > 1 and if the P/B

Answer 1

Normal P/B = 1

The normal P/B firm earns as expected rate on its book value equal to the required return , the expected residual earning is zero

If the P/B > 1, the frims equity will set at a premium to the book value The return earned is more than the return required.

If the P/B

Question 2

What does ROCE measure

Go over the formula sheet make sure you understand how to do the equation for RE.

Answer 2

The actual return earnt by the the firm.

Go over the formula sheet make sure you understand how to do the equation for RE.

Question 3

What are the two driver of residual earnings

Answer 3

1. ROCE

If the forecasted ROCE equals the required return, then RE will be zero, and V=B
IF the forecasted ROCE is greater than than the required return, then V > B
If the forecasted ROCE is less than the required return, then V

2. Growth in Book value

Net assets put in place to earn the ROCE. RE will changes in ROCE and growth in book value

Question 4

What is an alternative method for the calculating the RE from a project

Answer 4

Pv of all RE = Value of the project - Book value of assets (simple NPV calculation should yield the same results as RE

Question 5

1. If abnormal earning growth is expected to be zero….
   what is the asset worth and what is the P/E ratio
2. Earnings come from what two sources

Answer 5

1. The asset is worth Capitalized forward earnings or (EPS / R)
   P/E is normal or = 1
2. Earning from the asset
   Earning from reinvesting dividends