Chapter 2- Measuring returns to shareholders Flashcards
What is capital?
amount of long-term finance committed by investors
e.g long-term debt finance (long loans), preference shares (shares that pay a fix dividend, ordinary shares (equity finance)
What does ROCE mean?
Measure’s a company’s success by relating the amount of profit to the value of the resources employed in generating it. Reflects efficiency with which the resources have been used.
ROCE Formulas
profit before interest and tax (operating profit) / long-term debt + equity
Operating profit/ Total assets-current liabilities
What is Earnings per share (EPS)?
Shows the maximum dividend that could be paid to the owner’s of the business out of that year’s profit after all payments have been made.
What does EPS show?
The return earned by ordinary shareholders only, unlike ROCE which considers the return generated to all the investors.
Formula for EPS?
Profit after interest, tax and preference dividend / number of issued equity shares
Define ordinary shares and preference shares?
Ordinary: owner’s of company ; do not pay a fixed dividend
Preference: shares that pay a fixed dividend
What is a systematic and unsystematic?
Systematic- relates to a specific market
Unsystematic- relates to a specific company
What is the return expected by shareholders called?
Cost of equity (can be used to determine if the level of return - ie profit - that has been achieved is acceptable to shareholders
What does free cash flow to equity mean?
It’s the cash flows generated by a business in a particular year after interest and tax and investment spending. (FCFTE is then available to pay as dividend or to keep within a business as a benefit to ordinary shareholders)
What does free cash flows to the firm mean/show?
Cash flows generated by the business in a particular year after tax and investment spending but before interest.
What is the formula for discounting free cash flows for perpetuity?
cash flow / cost of capital (otherwise known as cost of equity)
How do you calculate the total shareholder return %?
(dividend per share / share price) + (capital gain or loss / share price)
