week 6

Question 1

What are Ordinary Shares?

Answer 1

Represent equity share capital of the firm

• Part Owners of the firm
• Vote at shareholder meetings
• Right to receive share of dividends distributed
• Each shareholder entitled to copy of the annual report
• No agreement between ordinary shareholder and company that the investor will receive back the original capital invested

Question 2

how are lenders compensated via debt financing

Answer 2

• Usually the lenders to the firm have no official control
• Usually requires regular cash outlays in the form of interest and the repayment of the capital sum (firm will be obliged to maintain the repayment schedule through good years and bad)

Question 3

hat are the disadvantages of Ordinary Shares for investors?

Answer 3

Last in the queue to have their claims met

Question 4

What is the importance of a well run stock exchange?

Answer 4

Firms can find funds and grow

• Allocation of capital
• Status and publicity
• Mergers
• Improves corporate behaviour

Question 5

What is the Dividend Valuation Model

Answer 5

P0 = D1 +P1 / (1+R)

Question 6

What is the calculation to the first Dividend Growth Model?

Answer 6

d1 = (1+g)d0

• Assuming dividends grow at a constant rate of G

Question 7

What is the second dividend growth model?

Answer 7

P0 = d1/r-g

Where:
p0 = Current Price
d1 = Future Dividend
r = Required rate of return
g = Growth rate of dividend

Question 8

What is the required rate of return based on the second dividend growth model?

Answer 8

r = d1/po +g

Question 9

What are the issues with the Divdend Growth Model?

Answer 9

1. Highly sensitive to the assumptions
2. The quality of input data often poor
3. If G exceeds R a nonsensical result occurs

Question 10

How can we forecast the dividend growth rates (g)?

Answer 10

Determinants of Growth:

1. The quality of resources retained and reinvested within the business
2. Rate of return on existing assets
3. Rate of Return earned on existing assets
4. Additional Finance

Growth - Focus on the firm:

1. Strategic analysis
2. Evaluation of Managment
3. Using historic growth rate of dividends
4. Financial statement evaluation and ratio analysis

• Growth - Focus on economy

Question 11

What are the downsides to using a comparison measure like the PER Model?

Answer 11

Some analysts use PER (P0/E0) to make comparisons between firms

• incorrectly assumes companies are correctly priced
• Fails to provide a framework for the analyst to test the important implicit input assumptions

Question 12

How do you calculate the Dividend Yield?

Answer 12

D/P

Question 13

How do you calculate the Dividend Payout ratio?

Answer 13

dps/ E
dps is dividend per share
E is earnings per share

Question 14

How do you calculate the Dividend Cover?

Answer 14

E/dps

Question 15

What are the ways we can quantify the risk and likely return of an investment?

Answer 15

Use probabilities to attach numbers to the likelihood of each state of the world occurring
- Look at Historical prices

Question 16

What is the Standard Deviation?

Answer 16

Measure of the dispersion of outcomes around the expected value. Most common measure of risk used in theory of investment.

Question 17

What are the formulas used for Standard Deviation

Answer 17

Standard Deviation = Square root of Variance

Variance = Sigma of (E(r) - ri) squared pi

Question 18

what is debt financing

Answer 18

company gets a loan and promises to pay the loan over a period of time with interest

Question 19

how do you calculate the variance

Answer 19

Porbability*( E(r) - r) ^2 (for all assets added )