Stock

Question 1

How can firms raise capital?

Answer 1

Borrowing (bonds, loans) or selling/issuing new shares

Question 2

What is equity?

Answer 2

The market value of all outstanding shares

Question 3

How can the firm’s value be decomposed?

Answer 3

Net Debt and Equity in market values

Question 4

Do stocks have pre-determined cash-flows?

Answer 4

No

Question 5

Do stocks have maturity date?

Answer 5

NO

Question 6

What is the difference in claim about bonds and stocks?

Answer 6

Bonds have priority claim and stocks have residual claim.

Question 7

Do holders of stock have voting rights?

Answer 7

Yes

Question 8

What are dividends?

Answer 8

The full amount of cash that goes to all outstanding shares.

Question 9

Does the value of a stock change if you hold it for different periods?

Answer 9

No, the holding period is irrelevant.

Question 10

What is the price’s equation for an investor that plans to never sell the stock?

Answer 10

P0 = ∞∑t=1 DPSt/(1 + re)^t

Question 11

What is the equation for the price of a stock?

Answer 11

p0 = DPS1/(1 + re) + DPS2/(1 + re)^2 + … + DPST/(re - gdps) * 1/(1 + re)^(T - 1)

Question 12

What are the relevant cash-flows when we want to find the stock’s price?

Answer 12

Dividends paid by the firm and selling the stock.

Question 13

What is the discount rate in stock?

Answer 13

Equity cost of capital, which represents the return demanded by shareholders to hold or buy stock from the company.

Question 14

What is the formula for DPS?

Answer 14

Dividend/N

Question 15

What are the assumptions to use the model to estimate DPS?

Answer 15

1) number of outstanding shares is kept constant
2) no external funding (debt/new equity)
3) takes one period for a given investment to start to generate some cash-flow (EPS)
4) from the moment that an investment is made it will generate the same cash-flow (EPS) in all periods unless stated otherwise

Question 16

What is the ROI?

Answer 16

Return on Invested Capital, which tells us how much EPS we can expect to generate given the ICt-1.
ROI = EPSt/ICt-1

Question 17

What does the ROIoverall tell us?

Answer 17

The profitability of all investments combined

Question 18

What is the relationship between the Dividend Payout Ratio (DPR) and the Retention Rate (RR)?

Answer 18

DPR + RR = 1
EPSt = DPSt + Retained EPSt

Question 19

How do you calculate the EPS?

Answer 19

EPSt = ROIoverall * ICt-1
EPSt = EPSt-1 + Retained EPSt-1 * ROINIt-1 (if changes in ROIoveral are due to new investments)

Question 20

What is the EPS growth rate?

Answer 20

geps = RRt-1 * ROINIt-1

Question 21

What happens to the geps when the RR is constant?

Answer 21

EPS grow at the same rate as dividends per share

Question 22

When should you start the perpetuity?

Answer 22

When RR and ROINI are costant.

Question 23

What is the total shareholder return?

Answer 23

Equivalent as the Holding Period Return.

Question 24

The Total Shareholder Return can be decomposed into:

Answer 24

Dividend Yield and Capital Gain

Question 25

What is the TSR's formula?

Answer 25

TSR0/1 = DPS1/P0 + (P1-P0)/P0

Question 26

Under the assumption of normal markets what is the TSR's relationship between re?

Answer 26

The E(TSRt/t+1) is equal to the re (the return demanded by shareholders)

Question 27

How can we tell if the firm's investment is good?

Answer 27

By the NPV If ROINI > re, NPV > 0 If ROINI < re, NPV < 0

Question 28

Why do we use the Present Value of Growth Opportunities (PVGO)?

Answer 28

The PVGO is used to overall qualify the firm's investments. It gives how much are investors willing to pay for the expectation of the firm's future investments and growth.

Question 29

What is the PVGO's formula?

Answer 29

PVGO = P0 - P0NoGrowth

Question 30

How can we use the PVGO to qualify the firm's investments?

Answer 30

If PVGO > 0 the majority of the firm's future investment have a positive NPV

Question 31

How do we calculate P0NoGrowth?

Answer 31

We set the RR for t>>1 equal to zero

Question 32

What are the limitations of the Dividend Discount Model?

Answer 32

1) There is a big amount of uncertainty associated with forecasting a firm's dividend growth rate and future dividends. 2) Small changes in the assumed dividend growth rate can lead to large changes in the estimated stock price. 3) The model is very rudimentary.

Question 33

What does the total payout model add?

Answer 33

Firms can remunerate their shareholders with dividends and share repurchases.

Question 34

What is the formula to find the share's price in the total payout model?

Answer 34

P0 = E0/N0 = PV(Future Dividends and Repurchases)/N0

Question 35

What happens when a firm repurchases stock?

Answer 35

When a firm uses excess cash to repurchase shares (stock), it decreases the amount available to pay dividends and the number of outstanding shares.

Question 36

What is the Free Cash Flow (FCF)?

Answer 36

The FCF represents the money generated by the firm's activities that is available to be paid to all shareholders and debtholders.

Question 37

How do we calculate the FCF?

Answer 37

FCF = EBIT * (1 - tax) + Depreciations - ∆NWC - CAPEX

Question 38

How do we calculate the EBIT?

Answer 38

Sales - Operation Costs - Depreciation

Question 39

What is the weighted average cost of capital (WACC)?

Answer 39

The appropriate discount rate for the firm's FCF

Question 40

What is the formula for the WACC?

Answer 40

WACC = D/Vl * rd(1 - tax) + E/Vl * re

Question 41

In the Free Cash Flow model how do we calculate the price of a share?

Answer 41

P0 = E0 /N0 =(Vl - Net Debt)/No

Question 42

How do we calculate the firm's value in the FCF Model?

Answer 42

Vlt = PV(FCF; WACC)

Question 43

What is multiples approach?

Answer 43

We estimate the firm's value based on the value of comparable firms.

Question 44

What is the multiples approach's main drawback?

Answer 44

Identical firms don't exist.

Question 45

What are the common characteristics for the multiples approach?

Answer 45

1) Same industry 2) Sell identical products (competitors) 3) Similar accounting ratios (ROI, debt-to-assets, profit)

Question 46

What are the most used multiples?

Answer 46

Price/Earnings (P/E) and Enterprise Value to EBITDA (EV/EBITDA)

Question 47

How do we calculate the forward Price-Earnings Ratio?

Answer 47

P/E = P0/EPS1

Question 48

What is the most appropriate ratio for investment decisions?

Answer 48

The forward P/E.

Question 49

What's the relationship between the PVGO and the P/E?

Answer 49

A higher PVGO means a higher P/E.

Question 50

How do we calculate the EV/EBITDA?

Answer 50

VL0/EBITDA0

Question 51

How does the EV/EBITDA relate to firms?

Answer 51

The EV/EBITDA is higher for firms with high growth rates and low capital requirements.

Question 52

How do we use the multiples approach?

Answer 52

1) Selection of peers 2) Selection of the multiple and use it for all peers 3) Take the average of the multiples and assume that average to be the multiple for your company 4) Multiply the average for the key driver of your company

Question 53

What are the multiples approach's main limitations?

Answer 53

1)Does not consider important differences among firms (only focus in one key driver). 2) Only provide information regarding the value of the firm relative to other firms in the peer group. Using multiples will not help us determine if an entire industry is overvalued/undervalued (for example the Internet boom of the late 1990s).

Question 54

True or false: The P0NoGrowth is always given by P0Nogrowth = EPS1/re .

Answer 54

False

Question 55

True or false: If changes in ROI (Overall) are due to new investments you can always compute the firm’s EPS as follows: EPSt = EPSt-1 + Retained EPSt-1 * ROINIt-1

Answer 55

True

Question 56

True or false: Dividends per share (DPS) are always expected to grow at the same growth rate asEarnings per share (EPS).

Answer 56

False

Question 57

True or false: Common stocks determine the market value of the firm’s Equity, that is the number of outstanding shares times the stock price.

Answer 57

True

Question 58

True or false: Common stocks have a defined maturity date.

Answer 58

False

Question 59

True or false: Common stocks have voting rights for the firm’s board of directors.

Answer 59

True

Question 60

True of false: Common stocks have the lowest priority over the firm’s assets in the event of bankruptcy.

Answer 60

True

Question 61

True or false: Consider a firm that after announcing that in the future it will retain more earnings to reinvest the money in its current activities sees the stock price lower than before the announcement (stock decreases). This implies that ROIC (Overall) is lower than the equity cost of capital (rE).

Answer 61

False

Question 62

True or false: Consider a negative shock in all the firm’s investments, due to economic changes in economic conditions. The invested capital from past investments will, after the shock, generate lower earnings (lower EPS).

Answer 62

True

Question 63

True or false: When the Retention Rate is constant over time the growth rate of DPS is constant over time.

Answer 63

False

Question 64

True or false: In the dividend discount model when ROINI and RR are constant in perpetuity the expected capital gain is equal to ROINI×RR.

Answer 64

True

Question 65

True or false: In the Dividend Discount Model the growth rate of DPS can always be computed through ROINI×RR.

Answer 65

False

Question 66

True or false: In the Dividend Discount Model, consider that changes on ROI(Overall) are due to new investments. In this case ROI(Overall) is computed through the weighted average of all individual past ROINI.

Answer 66

True

Question 67

True or false: A firm’s equity value is the market value of all outstanding bonds.

Answer 67

False

Question 68

True or false: Bonds represent one possible type of debt for the firm.

Answer 68

True

Question 69

True or false: Debtholders have a higher priority claim over the firm’s assets than stockholders in the event of bankruptcy.

Answer 69

True

Question 70

True or false: The firm’s Free Cash Flows can be computed as follows: 𝐹𝐶𝐹 = 𝐸𝐵𝐼𝑇𝐷𝐴 × (1 − 𝜏𝐶 ) + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛𝑠 − ∆𝑁𝑊𝐶 − 𝐶𝐴𝑃𝐸𝑋.

Answer 70

False

Question 71

True or false: WACC (Weighted Average Cost of Capital) is the discount rate used to compute the firm’s value (V).

Answer 71

True

Question 72

True or false: The firm’s equity value is the market value of all outstanding stock.

Answer 72

True

Question 73

True or false: Free Cash Flows represent the amount of money that the firm pays to its shareholders.

Answer 73

False

Question 74

True or false: WACC (Weighted Average Cost of Capital) is the discount rate used to compute the present value of all the firm’s future dividends.

Answer 74

False

Question 75

True or false: The firm’s equity value is equal to the firm’s value (V) minus its net debt.

Answer 75

True

Question 76

True or false: In the dividend discount model if the firm increases its dividend payout ratio, its current stock price will increase.

Answer 76

False

Question 77

True or false: In the dividend discount model if the firm announces that will no longer invest in previously scheduled projects with 𝑅𝑂𝐼𝑁𝐼 < 𝑟𝐸, the firm’s current stock price will increase.

Answer 77

True

Question 78

True or false: In the dividend discount model if the firm announces that it will pursue projects with a lower 𝑅𝑂𝐼𝑁𝐼, the firm’s future 𝑅𝑂𝐼(𝑂𝑣𝑒𝑟𝑎𝑙𝑙) will decrease.

Answer 78

True

Question 79

how do you compute the price of a stock for the year before the perpetuity begins?

Answer 79

DPSt+1 / (re-g)

Question 80

how do you compute the price of a stock for the year the perpetuity begins?

Answer 80

(DPSt * (1 + g)) / (re-g)

Question 81

how do you calculate the ROINI?

Answer 81

ROINI1Y = (EPS2-EPS1) / RET. EPS1

Question 82

how do you calculate the EPS when changes in ROI are due to new investments?

Answer 82

EPS2 = EPS1 + RET. EPS1 * ROINI1Y