Week 3 Dam 3,4

Question 1

Conventional accounting expenses can be categorized in 3 groups:

Answer 1

1. Operating expenses (labor, arterial): they generate benefits only for the current period.
2. Capital Expenses (CapEx) (land, buildings) generate benefits over multiple periods.
3. Fianncial Expeses (interest rate experses) associated with non-eqity financing

Question 2

Adjusted book value of equity =

Answer 2

book value of equity +
value of the reasherch asset

Question 3

What is earning management?

Answer 3

Earnings management is the use of accounting techniques to produce financial statements that present an overly positive view of a company’s business activities and financial position

Question 4

Why do firms manage earnings?

Answer 4

Firms generally manage earnings because they believe that they will be rewarded by markets for delivering smoother earnings and come consistently above matkers estimates.

Question 5

Why must we be cautious when using the current year’s earnings as a base for projections?

Answer 5

Because firms tend to do earings management.

Question 6

When firms dinest assets the can generate income in the form of…

Answer 6

…capital gains.

Question 7

Expected growth in net income = (Equity reinvestment rate)(Return on equity)

Answer 7

(Equity reinvestment rate) X (Return on equity)

Question 8

Increasing leverage will lead to a higher return on equity if the pre-interest, after-tax return on capital (ROC) exceeds …

Answer 8

…the after-tax interest rate paid on debt.

Question 9

Whats the difference between T-Bills and T-bonds?

Answer 9

Treasury bills have much smaller maturity period (weeks) where as tresury bonds can go up to years

Question 10

An integral component of the capital asset pricing model (CAPM), beta quantifies the relationship between …

Answer 10

systematic risk and the expected return.

Question 11

β > 1: Shares are … than the market.

Answer 11

riskier

Question 12

β = 1: Shares are … the market

Answer 12

just as risky as

Question 13

β = 0: Shares … the market

Answer 13

have no correlation to

Question 14

Claim : Levered beta is the beta of a firm that includes the effects of the capital structure.

Answer 14

True

Question 15

The levered beta of a firm is different than the unlevered beta as it changes in … correlation with the amount of debt a firm has in its financial structure.

Answer 15

positive

Question 16

When it comes to unlevered beta, you can essentially assume that the company is financed entirely with …

Answer 16

equity

Question 17

Unlevered beta gives the firm’s beta under no …

Answer 17

debt

Question 18

What is an LBO?

Answer 18

A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition.

Question 19

“Equity β” is called the …

Answer 19

levered β

Question 20

To get value of the equity we discount with…

Answer 20

CoE

Question 21

To get value of the Firm we discount with…

Answer 21

WACC

Question 22

Discounting cashflows to equity at the weighted average cost of capital will lead to an … estimate of the value of equity.

Answer 22

upwardly biased

Question 23

Discounting cashflows to the firm at the cost of equity will yield a … estimate of the value of the firm.

Answer 23

downward biased

Question 24

Expected growth for the firm, g is growth in…

Answer 24

operating earnings

Question 25

Expected growth for the equity, g is growth in...

Answer 25

Net Income or EPS

Question 26

EBIT - Taxes =

Answer 26

Net income

Question 27

Net income + Depriciation =

Answer 27

Operationg CF

Question 28

Claim: There may be far less private information and far more public information in most analyst forecasts than is generally believed

Answer 28

True

Question 29

Claim: A stable growth rate cannot be higher than the growth rate of the economy in which the firm operates.

Answer 29

True

Question 30

Why might the gemetric avg. be prefered over arithmetic avg. ?

Answer 30

Because the Geometric average is **less sensitive to outliers** and incorporates the fact that **returns might be negatively correlated** over time.

Question 31

Risk-free rate of short-term investment: T-bills or T-bonds?

Answer 31

T-bills

Question 32

How much of the risk in the company can be attributed to business risk and how much to financial leverage?

Answer 32

The proportion of the risk of the firm’s equity that can be attributed to business risk = βU/βL, while the remainder is due to financial leverage risk = βU/βL - 1

Question 33

HP is presented as divisions. You estimate the levered beta for Hewlett-Packard as a company. Is this beta going to be equal to the beta estimated by regressing past returns on HP stock against the market index? Why or why not?

Answer 33

NO. Since the **divisional structure and leverage** of Hewlett Packard has probably **changed over the years,** the beta obtained by regressing past returns of HP against a market index will not be the same as the one using the formula.