WEEK 7 Flashcards
(23 cards)
When managers invest in projects with positive NPVGOs, the firm value ______.
increase
The estimated share price would be too __ if earnings were discounted instead of dividends.
high
A firm may choose not to pay dividends so as to
finance profitable investments.
Which of the following variables can affect the price of a share based on the dividend growth model?
The growth rate
The discount rate
A long-term steady growth in dividends can be achieved with a ______ investment in growth opportunities.
continual
Firm value can be increased when
earnings are retained.
When a firm has many growth opportunities, it is quite likely to
pay no dividends.
Which of the following must hold true so as the dividend growth model can be implemented?
The growth rate must be lower than the discount rate
Dividends must grow at a steady rate
The equity valuation model, according to which the dividends per share are expected to grow at a steady rate in perpetuity, is called the
dividend growth model
To increase the value of the firm, the projects it invests in must have a net present value which is
positive
Reason: A zero NPV neither loses nor gains value but investing in a number of such projects would result in a stagnation in the firm’s value. and A negative NPV would lose money (and hence value) to the firm.
A growth perpetuity that has a current value of £50 when the interest rate is 8% p.a. and the growth of the perpetuity is 3% p.a. would be paying
Reason: Perpetuity = £50 x (8% - 3%) = £2.50
EPS for BMW next year are expected to be €20. The company has a dividend payout ratio of 20% and the required return on its shares is 10%. Under the assumption that BMW’s growth rate will be 6% in the foreseeable future, what is its price per share?
Reason: PBMW = (€20x0.2)(0.10−0.06)
= €100
Which calculations are required for the valuation of an equity security based on the NPVGO model?
The net present value of all growth opportunities
the net present value of a single growth opportunity
The share price with no growth opportunities
Imagine a firm whose current earnings per share is £100. If the firm retains 40% of its earnings, the return on retained earnings is 10% and the discount rate is 8%, calculate the NPV of the growth opportunity.
-(40%£100)+ 10%(40%*£100)8%
=£10
HSBC is expected to have EPS of £8 per year. If the bank’s NPVGO is £40 and the required rate of return on its shares is 16%, what is its share price?
Reason: PHSBC = (£8/0.16) + £40 = £90
A growth perpetuity, paying £3.80 next year and growing at 5.5% per year, at an interest rate of 7% p.a. would be worth:
Reason: 3.80.07−0.055
= £253.33
When a firm has many growth opportunities, it is quite likely to
pay no dividends.
Bid price and Ask price
Bid price =Price paid when selling
Ask price = Price paid when buying
The PE ratio is
negatively related to the firm’s discount rate.
The discount rate is ______ related to the equity’s risk (or variability) which means that the PE ratio is negatively related to the equity’s risk.
positively
Firms A and B both have EPS of £2. However, the net present value of growth opportunities for company A is £10 but only £5 for company B. All else constant, which firm should have a higher PE ratio and why?
Company A as the PE ratio is positively related to the NPVGO
When a price is set for an asset, the market is simply pricing ______ of the future.
perceptions
Suppose that a firm’s current earnings per share is £12. Moreover, the firm is a cash cow. Calculate the firm’s share price if the discount rate is 25%.
Reason: £12/25%=£48.
