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91 Cards in this Set
- Front
- Back
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If a firm has a WACC of 12%, what would this mean generally?
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A firm must make atleast this much on its existing assets. Anything more is profit.
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What influences the cost of capital?
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The riskiness of the project.
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Why are after tax figures used in cost of debt but not equity?
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Interest Expenses are tax deductable.
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What influences the cost of debt?
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The interest rate.
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How do you calculate the weight of debt for the WACC formula?
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Face Value of the Bond x Number of Bonds
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How do you calculate the risk on debt for the WACC formula?
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Use the calculator to determine the interest rate. Then:
Interest Rate x (1-t) |
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How do you calculate the weight of equity for the WACC formula?
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Price per Share of Common Stock x total Common Stock shares outstanding
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How do you calculate the return on equity for the WACC formula?
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Four Ways:
1) Risk Free Rate + (Beta x Market Risk Premium) 2) Risk Free Rate + Beta(Required Rate of Return - Risk Free Rate) 3) (Dividend / Price per Share) + Growth 4) Use calculator to calculate the interest rate, then + Risk Premium |
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How do you calculate the weight of Preferred Stock for the WACC formula?
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Price per Share x Total Shares Outstanding
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How do you calculate the cost of equity for the WACC formula?
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Dividend / Price per Share
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Does each component in the WACC formula use before or after tax figures?
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After tax figures are used. Thats why Debt is multiplied by (1-t). Equity and Preferred Stock are not tax deductible so they need no calculation.
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The Risk Premium on a bond is usually between what 2 numbers?
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4% to 6%
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What's a shortcoming of the dividend valuation model?
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It assumes that earnings and dividends per share are growing constantly.
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How does the tax rate affect the WACC of a firm with debt financing?
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The higher it is the lower the WACC will be.
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The cost of debt is in essence what?
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The YTM on a bond adjusted with reference to tax.
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What does Beta measure?
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The systematic risk of a stock.
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How does the security market line approach account for systematic risk of a stock?
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It compares the risk against of one stock against the rest in the overall market.
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What is a pure play strategy?
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Basing your required rate of return for a cost of capital calculation off of a different company in the same field as the project.
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What are the affects of a hurdle rate?
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It increases the required rate of return in riskier than average projects and lowers the required rate of return in safer than average projects.
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When market interest rates increase what happens to the cost of capital for a leveraged firm?
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It increases the return on debt and furthermore increases the WACC.
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How does debt effect EBIT?
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It doesn't.
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What is business risk?
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The risk associated to a firms operations. Examples: fluctuations in demand, competition, and fixed costs. It's the risk that would exist if a company had no debt.
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How can you measure business risk?
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By measuring the variability in EBIT.
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What is financial risk?
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It is the risk associated with a firm's use of debt.
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How can you measure financial risk?
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Looking at variability in ROE and earnings per share.
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What does the EBIT-EPS indifference point tell us?
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It's the point when comparing 2 plans where the earnings per share would be the same regardless of what plan was chosen.
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What would be the result of an EBIT that is higher than the break even point?
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Earnings per share in plan B are higher than earnings per share in plan A.
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What would be the result of an EBIT that is lower than the break even point?
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Earnings per share in plan A are higher than earnings per share in plan B.
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What are the biggest things that influence capital structure?
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The exchange between risk and returns. Tax positions and financial flexibility also influence these decisions.
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What is the relationship between business risk and the amount of debt a company accumulates?
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The higher a company's business risk the lower amount of debt financing the firm should utilize. Debt increases business risk.
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How are taxes and interest expenses related?
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The more interest a company expenses the less taxes will be. However the more debt sheltered from taxes a company has the less attractive the additional interest becomes.
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What does financial flexibility refer to in a firm?
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The ability to raise money in bad/severe conditions.
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How does demand affect business risk?
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The more variablity in demand the greater the business risk. If a company doesn't know how much it can sell in a year it can't accurately measure if it can meet it's obligations or not.
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How does sales price affect business risk?
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The more stable a product's price is the less the risk. More stability = more accurate revenues.
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How does raw material price affect business risk?
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If CGS are highly changing this increases the business risk.
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Operating leverage refers to what in regards to business risk?
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The amount of fixed costs a company utilizes. The more fixed costs a company has the greater the business risk.
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What is the affect of using additional debt in a firm's capital structure?
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The amount of EPS & ROE expected increases as well as the variability.
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If projected EBIT is lower than the EBIT-EPS breakeven point, what should a firm do?
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Choose a capital structure with less debt.
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If projected EBIT is higher than the EBIT-EPS breakeven point, what should a firm do?
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Choose a capital structure with more debt.
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What happens if (EBIT / Total Assets) is greater than the cost of debt?
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Return on Equity and Earnings per Share increase.
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What happens if (EBIT / Total Assets) is less than the cost of debt?
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Return on Equity and Earnings per Share decrease.
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What is the declaration date?
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The day when firms announce the date and amount of a dividend.
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What is an ex-dividend date?
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The date that specifies who will receive a dividend in the case of a recently sold share of stock.
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What happens to a stock price on the date of ex-dividend?
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The stock price falls by the amount of the dividend.
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What happens on a record date?
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A list of stockholders is collected in order to mail out the dividends.
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What is a payment date?
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The day a company mails a dividend check.
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How do you calculate a dividend yield?
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The Dividend / Price per Share.
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What does the dividend payout rate tell you and how is it calculated?
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Its calculated by Dividend per Share / Earnings per Share. It tells you the percentage of retained earnings being paid out.
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Where do capital gains comes from?
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From a firm retains earnings and reinvests them. This creates growth and increases stock prices.
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Why is a desire for income not a valid argument for a high payout rate?
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If you really need income you can sell you shares of stock.
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Whats the bird in hand theory?
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It is better to have cash dividends in an investors hand than it is to risk them investing it foolishly.
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What is the relationship between the amount of dividends paid and stock price?
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When dividends increase, so do stock prices. When dividends decrease, so do stock prices.
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What differs with regard to the size of the price change in a dividend?
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When dividends increase, price increases alittle. When dividends decrease, price decreases alot.
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What is the constant payout rate?
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A percentage of earnings that is paid each period as a dividend.
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What is a low regular and extra payment policy?
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Having a lower than normal dividend each period and paying extra dividends after a period with high earnings.
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What is a constant growth / constant dollar policy?
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Firm adopts a dividend policy they know they can afford. This leaves extra money for growth. The most popular.
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What is a residual dividend model?
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Earnings that aren't used to finance projects are paid as dividends. More projects = less dividends. Less projects = more dividends.
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How can a firm minimize flotation costs associated with issuing new securities?
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Utilize a residual dividend policy.
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What is empire building?
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Investing in negative NPV projects that lower the value of a firm.
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Whats the clientele effect indicate?
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That investors purchase shares with companies that have the same dividend policies as themselves.
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What dividend policy fluctuates the most?
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Residual dividend policy.
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Stock repurchases indicate what?
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The company thinks shares are undervalued and their price will increase after the repurchase.
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What are the most important factors in following dividend policy according to most CEO's?
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Maintaining historic dividend policy, Flotation costs with regard to equity, and attracting institutional investors to purchase stock.
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What is the order on a income statement?
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Sales
(CGS) Gross Profit (Operating/Admin Expenses) EBIT (Interest) EBT (Taxes) Net Income |
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What do you get if you subtract dividends from Net Income?
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Change in Retained Earnings
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What do you get if you multiply Par Value times the number of shares?
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The amount of Common Stock.
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What is a trend analysis?
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Comparing values across time.
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What is a Cross-Sectional Analysis?
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Comparing different firms across the board.
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What are all figures divided by in common size financial statements?
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The biggest number on the statement. Sales for income statements and total assets on the balance sheet.
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What are the liquidity ratios and what do they do?
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The current ratio and the quick ratio. They measure the firm's ability to meet upcoming obligations.
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What does the current ratio tell us about a firm?
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Indicates how liquid the firms current assets are.
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What does the quick ratio tell us?
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Shows a better relationship between current liabilities and the most liquid assets. Inventory is already very liquid and taking it out gives us a better usderstanding of the true relationship.
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What are the asset management ratios and what do they tell us?
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They are inventory turnover, accounts receivable turnover, days sales outstanding, and asset turnover. They indicate the firms efficiency of managing assets in comparison to the amount of sales generated.
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What does the inventory turnover ratio tell us?
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How fast inventory is converted to sales. Also indicates how many times a company is restocking their inventory in a given year.
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What does the days sales outstanding ratio tell us?
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On average how long it takes a person to pay for a purchase they made on credit. This number should be smaller than the amount of days a firm's credit policy limits.
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What's a problem with the asset turnover ratio?
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When comparing an older firm to a newer firm your results could be skewed.
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What are the leverage and coverage ratios and what do they tell us?
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They are the debt ratio, debt to equity ratio, and times interest earned ratio. They represent the ability to pay interest and repay debt.
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What does the debt ratio tell us?
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How much of assets were provided by crediors.
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What does the debt to equity ratio tell us? What would owners and lenders prefer?
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How much the firm owns in comparison to what it owes. Owners want it above 1 and lenders want it below 1.
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What does the times interest earned ratio tell us?
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Measures the firms ability to meet annual interest payments.
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What are problems with TIE?
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Doesn't include principal payments which can cause a bankruptcy. Also it includes depreciation and amortization expenses which are not actual cash flows.
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What are the profitability ratios and what do they tell us?
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They are the net profit margin, operating return on assets, operating return on assets, and return on equity. They measure profitability of a firm.
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What does the net profit margin tell us?
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This measures net income per each dollar of sales.
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What does the operating return on assets tell us?
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It calculates the basic earning power of a firm.
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What does the return on assets tell us?
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It tells you what earnings were generated from invested assets.
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What does the risk on equity tell us?
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It tells us the rate stockholders are earning on their shares, essentially how much profit a company makes with invested shareholder dollars.
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What are the market value ratios and what do they do?
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They are the price earnings ratio, the market to book, and the PEG ratio. They relate firms stock price to earnings.
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What does the P/E ratio tell us?
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How much investors are willing to pay for $1 of reported profits. Higher P/E ratios are better.
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What does the market-to-book tell us?
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It relates what investors believe a firm is worth in comparison to what accountants say its worth. It stops investors from paying for overpriced stocks.
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What are some limitations to ratio analysis?
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Difficult with large complex firms, inflation changes ratios, seasonal factors distort ratios, firms use different accounting methods and credit policies which distort comparisons.
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What does the equity multiplier measure?
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The firms use of financial leverage,
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