WACC Flashcards
To remember key formulas
What is ROE and recall its formula
Return on Capital employed and
ROE = Total profit/opening net assets(equity book value)
or profit = Equity book value * ROE
How to derive the share price if dividend is constantly growing
P=D(1+g)/ke-g
or
Ke=D(1+g)/p+g
recall formula for gordon’s growth model
g=b*r
G=growth
b=ROE
r=retention ratio
recall different growth rates formulas
- Dividend history
g=(latest dividend/old dividend)^1/n -1 - Gordon’s model
g=b*r - Profit growth rate
g=(latest profit/old profit)^1/n -1 - Net assets growth
g=(latest NA/old NA)^1/n -1 - Retained profits to opening Net assets
g= Retained profits/opening NA
what is price earning multiple and what does it mean?
- Higher P/E indicates the greater confidence of investor in the company
- It shows how much amount investor is paying per rupees earning
Formula= price/earning
or price per share/EPS
what is dividend cover
dividend cover is profit over dividend formula is
Dividend cover = Profit/dividend
or EPS/DPS
Higher times means company pay less dividend
The investor of this company will earn less dividend but will be benefitted in form of capital gain when he will sell the shares.
what is dividend yield?
dividend yield is how much dividend an investor has earned on a particular price.
formula= dividend/price
dividend payout ratio formula
dividend/profit or earning(EPS)
what is the relation between the P/E ratio and dividend cover ratio
You can drive the Dividend Yield from P/E and P/D which will be used in this formula as D/P
Ke=D(1+g)/p+g
recall the formula for IRR
a+[A/(A-B)]*(b-a)
a= chotay ka rate
A= chotay ki NPV
B= baray ki NPV
b= bara rate
if the coupon rate for the bond in the market goes down after one year what should investment in such bond at higher or lower price?
Higher price because you coupon is giving you higher than market price
step involved in calculating the post tax kd when pre tax kd
calculate the market value using pre tax cash flows and pre tax rate
using the market value calculated in the step above put in post tax cash flows and market value calculate a rate which will be of post tax kd
answer this case scenario
post tax kd is given and market value is to be calculated.
- Draft cash flows individually with tax savings on interest.
- Find PV at post tax Kd to get market value.
answer this case scenario
MV of the bond is given and post tax kd is to be calculated
1, Draft cash flows by taking market value at year 0 and take tax savings on interest.
- Find IRR of post tax cash flows and market value.
answer this case
Pre tax kd is given and market value of bond and post tax kd are to be calculated
- find market value using pre tax cash flows discounted at pre tax rate
- Find post tax kd by finding IRR of market value and post tax cash flows.
what if in the question you are provided with market value of the preference shares and nominal rate but they won’t say anything about the period of redemption?
well if the market value is low and high then it is obvious that effective rate would be according to it because let’s say that the market rate is higher than the nominal rate of preference shares then other person would not buy it face value rather at discount rate this would make the effective rate higher and further if period is not given then it is understood that it is indefinite period.
What is the alternative method of calculating the WACC? what are the preconditions
WACC = PBIT/Total MV
if there is a tax then PBIT(1-t)
Total MV = Equity + Debt
Preconditions are
100% profit is distributable
Debt is irredeemable
in what cases the wacc will be changed by investing in new project?
when the project is large the capital structure changes
and when project has different business risk
what are the conditions when the existing wacc of the company equals to new wacc when company issues debt or equity to finance the project?
this is only possible if;
- Business risk does not change
- Financial risk does not change.
which companies total risk will remain same
companies operating in the same sector and having same debt to equity ratio
what are the assumption of MM theory if the level of gearing is increased if taxation is ignored
cost of equity increases as gearing increases to compensate shareholders for the increased risk associated with borrowing
as the level of gearing increases there is a greater proportion of cheaper debt capital in the capital structure of the company
as gearing increases the net effect of the greater proportion of cheaper debt and higher cost of equity in that WACC remains unchanged.
what is the first and 2nd preposition of MM theory without taxes.
WACC is constant at all levels of gearing for companies with identical profits and same business risk
cost of equity rises as the gearing increases and cost of equity will rise to the level such that given no change in debt, the WACC remains constant.
what is the formula of MM theory without taxes
WACCg = WACCu
or
KeG = Keu + (Keu-Kd) D/E
what is the MV of geared company if MV ungeared co and Debt is give
MVg = MVu + D x T
that MVg will be total market value and D*T represents the PV of tax savings discounted at Kd
[DKdTax rate]/kd
How calculate the MV of equity of geared company if you have calculated the total MV with this formula MVg = MVu + D x T and can I calculate the Ke if dividend is given?
before loan equity = 46,667
loan paid off = (20000)
tax savings = 6000 [20000*30%]
YES My Dvd/Mv(calculated above)
what is the formula to calculate the KEg with MM theory with taxes
Keg = Keu +(Keu-Kd)x D(1-t)/E
how to calculate the WACCg if WACCu is given
there are two ways
1.WACCg = WACCu x (1-DxT)/E+D)
and other is
2. PBIT(1-t)/Total market value
capm formula
Ke of A = Rf+(Ra-Rf)*beta
beta = CoVam*stand dev A/Stand dev ma
or
premium of A/premium of market
what is treynor ratio formula
the ratio measures the risk premium of the portfolio where the risk premium is the difference between the return and risk free rate and the risk premium is related to the amount of systematic risk present in the portfolio.
(expected return or return on portfolio - Rf)/Beta
what is Sharpe ratio
(Expected return on Portfolio or return on Port - Rf)/risk on portfolio
it measure the risk premium of portfolio relative to the total amount of risk in the portfolio
also called reward to variability ratio
how the portfolio beta is calculated?
(investment x beta ) for each given investment divided by the sum of investment
what to do when value of portfolio is asked at the year end
Just simply compound each investment with Ke or expected return calculated as per CAPM formula for one year
50 x (1+26%) = 63
what if the valuation of security is given at the year end then how to calculate the value of investment at year end
find ke
then, ke-dividend yield = growth rate
then, compound investment cost for one year with this growth rate
alternative formula to calculate the Beta when playing with COva and correlation
CoVam = Sam x SDa x SDm
Sam = CoVam/(SDa x SDm)
Beta = SDa x Sam/Sdm
alternatively
Beta = CoVam/SDm^2
how to gear up the beta asset and why we do that?
the beta asset represents the volatility of returns or systematic return of security in relation to the market. we gear up the beta to find what would be the beta equity for the company if we introduce the debt finance
Ba = Be x D/(E+D)
how to calculate the portfolio beta?
- find the Keg using capm formula with beta equity(derived)
- multiply the investment with (1 + Keg)-dividend
3.mulitply the calculated beta in step 1 with investment calculated in step 2 and divide the answer with answer in step 2
write different ways in which beta can be calculated
Beta = systematic risk of A/Market risk
Systematic risk = Correlation x Security risk
Beta = Covariance between Market and security / Market risk ^2
Risk premium of A/ Risk Premium of market
Expected return - Rf/Market return- Rf
How the TERP is calculated?
The TERP is the price of the share after issuing the right shares and the right shares are normally issued at lower than the cum right price of the share
it is calculated just like the wacc
what is base case NPV
base case NPV is calculated by DCF assuming that the project is financed entirely by equity which is Keu and which can be calculated using CAPM formula with Beta Asset or WACCg = Keu x (1- Dxt/E+D)
