Los 46.e

Question 1

How to work out a one year holding period DDM

Answer 1

Dividend + Year End price / (1+Required rate of Return)

Question 2

How to workout a multi period dividend?

Answer 2

Dividend/(1+Rate) + Dividend/(1+Rate)^2 + Dividend/(1+Rate)^3

Question 3

Why is Free Cash flow to equity used?

Answer 3

It’s often used in DCF models because it represents the potential amount of cash that could be paid out to common shareholders. E.g. it’s capacity to pay dividends
Good for firms that do not pay dividends

Question 4

How do you work out FCFE

Answer 4

FCFE - Cash Flow from Operations - Fixed capital Investment + net borrowing
or
FCFE = net income + Depreciation - increase in working capitla - fixed capital investment - debt princopal repayments + new debt issues

Question 5

How is the required rate of return for use in present value models estimated

Answer 5

It is estimated using a CAPM (Capital Asset Pricing Model)
Require rate of return on share i = Current expected risk - free rate of return + Beta*Market risk return)

Question 6

What’s the relatonship of the stocks value with the require return of equity and projected growth rate of dividends?

Answer 6

• As the difference between ke and gc widens, the value of the stock falls.
• As the difference narrows, the value of the stock rises.
• Small changes in the difference between ke and gc can cause large changes in the stock’s value.

Question 7

How can you use the growth model to determine how much of estimated stock is due to dividend growth?

Answer 7

Value of stock with growth rate - Value of stock with a growth rate of 0

Question 8

How do you estimate growth rate in dividends?

Answer 8

• Use the historical growth in dividends for the firm.
• Use the median industry dividend growth rate.
• Estimate the sustainable growth rate.

Question 9

What is the sustainable growth rate and how do you work it out??

Answer 9

The sustainable growth rate is the rate at which equity, earnings and dividends can continue to grow indefinitely
sustainable growth = (1 − dividend payout ratio) × ROE

Question 10

How to work out the value of a firm with no current dividend?

Answer 10

Say dividend is in year 4
V3 = D4 / Rate - Growth
V3 / 1+rate^3

Question 12

What is 1-dividend Payout ratio?

Answer 12

The retention rate