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Stock Flashcards

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Series 65 flashcards Series 79 Top-Off Exam flashcards
1
Q

How can firms raise capital?

A

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

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2
Q

What is equity?

A

The market value of all outstanding shares

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3
Q

How can the firm’s value be decomposed?

A

Net Debt and Equity in market values

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4
Q

Do stocks have pre-determined cash-flows?

A

No

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5
Q

Do stocks have maturity date?

A

NO

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6
Q

What is the difference in claim about bonds and stocks?

A

Bonds have priority claim and stocks have residual claim.

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7
Q

Do holders of stock have voting rights?

A

Yes

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8
Q

What are dividends?

A

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

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9
Q

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

A

No, the holding period is irrelevant.

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10
Q

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

A

P0 = ∞∑t=1 DPSt/(1 + re)^t

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11
Q

What is the equation for the price of a stock?

A

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

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12
Q

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

A

Dividends paid by the firm and selling the stock.

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13
Q

What is the discount rate in stock?

A

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

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14
Q

What is the formula for DPS?

A

Dividend/N

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15
Q

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

A

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

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16
Q

What is the ROI?

A

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

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17
Q

What does the ROIoverall tell us?

A

The profitability of all investments combined

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18
Q

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

A

DPR + RR = 1
EPSt = DPSt + Retained EPSt

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19
Q

How do you calculate the EPS?

A

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

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20
Q

What is the EPS growth rate?

A

geps = RRt-1 * ROINIt-1

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21
Q

What happens to the geps when the RR is constant?

A

EPS grow at the same rate as dividends per share

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22
Q

When should you start the perpetuity?

A

When RR and ROINI are costant.

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23
Q

What is the total shareholder return?

A

Equivalent as the Holding Period Return.

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24
Q

The Total Shareholder Return can be decomposed into:

A

Dividend Yield and Capital Gain

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25
Q

What is the TSR’s formula?

A

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

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26
Q

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

A

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

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27
Q

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

A

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

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28
Q

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

A

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.

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29
Q

What is the PVGO’s formula?

A

PVGO = P0 - P0NoGrowth

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30
Q

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

A

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

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31
Q

How do we calculate P0NoGrowth?

A

We set the RR for t»1 equal to zero

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32
Q

What are the limitations of the Dividend Discount Model?

A

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.

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33
Q

What does the total payout model add?

A

Firms can remunerate their shareholders with dividends and share repurchases.

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34
Q

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

A

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

35
Q

What happens when a firm repurchases stock?

A

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

36
Q

What is the Free Cash Flow (FCF)?

A

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

37
Q

How do we calculate the FCF?

A

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

38
Q

How do we calculate the EBIT?

A

Sales - Operation Costs - Depreciation

39
Q

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

A

The appropriate discount rate for the firm’s FCF

40
Q

What is the formula for the WACC?

A

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

41
Q

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

A

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

42
Q

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

A

Vlt = PV(FCF; WACC)

43
Q

What is multiples approach?

A

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

44
Q

What is the multiples approach’s main drawback?

A

Identical firms don’t exist.

45
Q

What are the common characteristics for the multiples approach?

A

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

46
Q

What are the most used multiples?

A

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

47
Q

How do we calculate the forward Price-Earnings Ratio?

A

P/E = P0/EPS1

48
Q

What is the most appropriate ratio for investment decisions?

A

The forward P/E.

49
Q

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

A

A higher PVGO means a higher P/E.

50
Q

How do we calculate the EV/EBITDA?

A

VL0/EBITDA0

51
Q

How does the EV/EBITDA relate to firms?

A

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

52
Q

How do we use the multiples approach?

A

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

53
Q

What are the multiples approach’s main limitations?

A

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).

54
Q

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

A

False

55
Q

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

A

True

56
Q

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

A

False

57
Q

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.

A

True

58
Q

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

A

False

59
Q

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

A

True

60
Q

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

A

True

61
Q

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).

A

False

62
Q

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).

A

True

63
Q

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

A

False

64
Q

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.

A

True

65
Q

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

A

False

66
Q

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.

A

True

67
Q

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

A

False

68
Q

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

A

True

69
Q

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

A

True

70
Q

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

A

False

71
Q

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

A

True

72
Q

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

A

True

73
Q

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

A

False

74
Q

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.

A

False

75
Q

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

A

True

76
Q

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

A

False

77
Q

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.

A

True

78
Q

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.

A

True

79
Q

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

A

DPSt+1 / (re-g)

80
Q

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

A

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

81
Q

how do you calculate the ROINI?

A

ROINI1Y = (EPS2-EPS1) / RET. EPS1

82
Q

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

A

EPS2 = EPS1 + RET. EPS1 * ROINI1Y

83
Q
A

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