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FM > Chapter 5 > Flashcards

Chapter 5 Flashcards

1
Q

Market value of any investment

A

Expected returns discounted at investors required rate of return

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2
Q

Ke (dividends constant)

A

D0/P0

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3
Q

P0

A

Price ex dividend

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4
Q

KE with dividend growth at g

A

ke = D0(1+g)/P0 + g

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5
Q

Dividend valuation model flaws

A
  • g must be less than ke, if equal, share price becomes infinitely high. growth rate to perpetuity this high impossible
  • In practice growth rates vary
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6
Q

During the period after announcement of dividend but before payment, prices…

A

Rise in anticipation of payment - share is cum div

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7
Q

When does a share go ‘ex-div’

A

Shortly before paid, anyone acquire afterwards will not receive the dividend

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8
Q

g can be calculated using which function

A

POWER

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9
Q

Input to power function

A

Most recent div/oldest dividend, 1/time period of growth

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10
Q

Garden growth model - g is calculated by

A

r * b
r = current accounting rate of return
b = proportion of profits retains

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11
Q

Accounting rate of return

A

profit after tax as percentage of opening capital employed (opening balance sheet values)

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12
Q

Issues with garden growth model

A

relies on accounting profits
assumes r and b are constants
inflation can distort accounting rate of return
assumes all new finance from equity

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13
Q

Issues with dividend valuation model - underlying assumptions

A

Assumes shares have value because of dividends - high tax rate investors likely prefer capital gains
Assumes dividends either don’t grow or grow constantly
Estimates of future dividends based on historical data - ignores future market conditions, investor confidence, economic conditions

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14
Q

Issues with dividend valuation model - data used

A

Share price is used, these can change daily and are not always rationally or efficiently

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15
Q

Issues with dividend valuation model - growth in future dividends

A

More likely linked to growth in earnings than to past dividends, but earnings do not feature?

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16
Q

Impact of a bonus issue on DVM estimate g

A

No cash - go back and adjust number of shares for bonus issue

17
Q

Impact of rights issue on DVM estimate g

A

No adjustment necessary, as inflow of funds

18
Q

Cost of equity - CAPM

A

ke = rf + 𝝱(rm-rf)

19
Q

Estimating 𝝱 factors

A

Examine 𝝱 of quoted companies in similar business
however often other firms engaged in several lines of business, different gearing etc.

20
Q

Cost of preference shares

A

Dividend / ex-div market value

21
Q

Cost of debt (irredeemable/current market price=redemption price)

A

annual interest (starting 1y)/market price

22
Q

Cost of debt redeemable at not current market price spreadsheet formula

A

RATE

23
Q

RATE inputs

A

number of period
amount of interest paid in a period
(PV) of asset - market price
Future value

24
Q

Gross redemption yield < couponrate

A

bonds issued at premium

25
Q

Gross redemption yield > coupon rate

A

bonds issued at discount

26
Q

Gross redepmtion yield = coupon

A

bonds issued at par

27
Q

KD with tax

A

Interest * (1-T)/P0

28
Q

Steps in determining convertible debentures

A
  1. calculate value of conversion option
  2. Compare conversion option with cash option choose higher
  3. use RATE to calculate pre tax YTM for redeemable
    No tax effect
29
Q

Calculating weights for WACC wherever possible should be based on

A

Market weights - mv for debt and equity

30
Q

Assumptions to use WACC

A
  • Historical debt/equity is not going to change
  • Systematic business risk of the firm will not change
  • Finance is not project specific
31
Q

Problems with WACC

A
  • Knowing which sources of finance to include (ST loans?)
  • Loans without market value (take book value)
  • Cost of capital for small companies - hard if unquoted and lack of liquidity from securities and being smaller makes more expensive to finance, also no share price

FM (11 decks)

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