Los 42.g Flashcards
(9 cards)
What’s the primary goal of firm management
Increase the book value of the firm’s equity and thereby increase the market value of its equity.
What’s the difference between Book Value of Equity and The Market Value of Equity?
Book value of equity = the value of the firm’s assets on the balance sheet minus its liabilities.
Market value of equity = the total value of a firm’s outstanding equity shares based on market prices and reflects the expectations of investors about the firm’s future performance.
Why are they not equal sometimes
Book value does not reflect investor expectations about future firm performance.
How do you workout Return on Equity
Net Income (t) / Average BV
NI / ((BV t + BV t-1)/2) = if theres high volatility
NI / BV t-1 = If there’s low volatility or examining ROE over a no. of yrs
How do you work out Price to book Ratio
Share price / Book Value
What is a firms Cost of Equity?
Expected equilibrium total return (including dividends) on its shares in the market.
What is the relationship between share price and expected return?
Inverse relationship. A decrease in share price increases expected return, and an increase in share price decreases expected return (all else equal).
How does the required return affect a stock’s intrinsic value?
Inverse relationship. A higher required return decreases intrinsic value (and vice versa), as intrinsic value is the present value of future cash flows discounted at the required return.
How do investors use the expected return and required return to make investment decisions?
Investors compare their minimum required return (given the risk) to the stock’s expected return. If the expected return is higher, the stock is considered an attractive investment.
