Questions of Marks 3:-
How can u measure market risk (beta)? 3 marks
Market risk is measured by beta, which is another measure of investment risk that is based on the volatility of returns. In contrast to standard deviation, beta measures volatility relative to a relevant baseline rather than to the mean of the asset that is being evaluated. Beta is the appropriate measure of an asset’s contribution to your portfolio’s risk, as it measures only systematic risk, i.e., market risk
What is Pure Play?
Pure Play
Using WACC blindly can lead to severe problems for a firm. Because we cannot observe the returns of these investment, there generally is no direct way of coming up with the beta. The approach must be to find a project or another firm in the industry in which our proposed project falls. We can use the beta of that firm along with the D/E ratio prevalent in that industry.
What are IPO’s and what is the main objective of IPO’s
IPS stands for initial public offering. Companies launch their shares in market through IPO’s.
Does value of a firm increased with increase in its proportion of debt financing.
M & M model says that debt financing increases the value of firm due to tax shield. However, there are certain aspects of high gearing that discourage borrowing.
How stable dividend policy could increase the marketability of a firm’s shares?
Stable dividend per share: look favorably by investors and implies low risk firm. it increases the marketability of firm’s share. Cash flow can be planned as dividend amount can be ascertained with accuracy (aid in financial planning)
Differentiate between the single period capital rationing and multi-period capital rationing.
Single period capital rationing:
It is a situation where the company has limited amounts of funds in one investment period only. After that period, the company can access funds from various sources, e.g. issuing shares, borrowing from banks or issuing bonds.
Multi-period capital rationing:
When capital is in limited availability in more than one period and selection of projects cannot be made by ranking projects according to PI, this situation is known as multi-period capital rationing.
Why weighted average cost of capital (WACC) should be used as discount rate for
Analyzing the financial viability of a project?
The discount rate used to find out the PV of future cash flow is normally the WACC.
In the year ending January 2008, Wal-Mart paid out Rs.1,326 million as debt interest. How much more tax would Wal-Mart have paid if the firm had been entirely financed by equity? What would be the present value of Wal-Mart’s interest tax shield if the company planned to keep its borrowing permanently at the 2008 level? Assume an interest rate of 8% and a corporate tax rate of 35%.
Answer:
More tax in case of entirely finance by equity:
1326 million *35/100 =464 million
Present value of interest = 1326 million /1 .08 =1218.75 million
How stable dividend policy could increase the marketability of a firm’s shares?
Answer:
Stable dividend per share: look favorably by investors and implies low risk firm. It increases the marketability of firm’s share. Cash flow can be planned as dividend amount can be ascertained with accuracy (aid in financial planning)
Differentiate between the single period capital rationing and multi-period capital rationing.
Answer:
Single period capital rationing
It is a situation where the company has limited amounts of funds in one investment period only. After that period, the company can access funds from various sources, e.g. issuing shares, borrowing from banks or issuing bonds.
Multi-period capital rationing:
When capital is in limited availability in more than one period and selection of projects cannot be made by ranking projects according to PI, this situation is known as multi-period capital rationing.
A public limited Company is expected to pay Rs.0.50 per share dividend at the end of the year. The dividend is expected to grow at a constant rate of 7% per year. The required rate of return on the stock is 15%. What value per share of the Company’s stock is expected one year from now?
D2 = D1(1+g)
= .5(1.07)
= .535
P1 = D2 / r – g
=.535/.15-.07
= . 535/.08
= 6.69
Levered and un levered for firm
The amount of debt used to finance a firm’s assets. A firm with significantly more debt than equity is considered to be highly leveraged.
Leverage is most commonly used in real estate transactions through the use of mortgages to purchase a home.
A firm with no debt in its capital structure known as un levered firm
Compare and contrast the Stable Dividend per share policy and Constant dividend payout policy.
CONSTANT DIVIDEND PAYOUT
A fixed %age is paid out as dividend. Under this policy the dividend amount will vary because the net income is not constant.
STABLE DIVIDEND PER SHARE:
Per share fixed amount of dividend paid every year. Look favor ably by investors and implies low risk firm. Investors can easily forecast and predict their earnings. Aid in financial planning
Differentiate AGGRESSIVE AND DEFENSIVE STOCKS
Aggressive
Stocks have high betas, greater than 1, meaning that their return is more than one-to-one to changes in return of overall market.
Defensive
stocks are less volatile to change in market return and have beta of less than one
Difference between Soft and hard capital rationing
Capital rationing can be classified into hard and soft, based on whether the factors are external or internal. Hard capital rationing is when constraints that may affect business decisions are externally determined; hard capital rationing does not occur under perfect market conditions. Soft capital rationing occurs when investment expenditure is controlled and limited internally, by restrictions imposed by management.
How you suggest high or low debt financing for:
A) Firm paying high tax
In this case i suggest that firm should do high debt financing so firm can reduce its tax.
B) Firm paying no tax
In this case i suggest that firm should do low debt financing because firm is already not paying any tax so no need for high debt financing in this situation for the purpose of tax payment
Question:-
Projects |
Beta |
Standard deviation |
| Security X | 0.8 | 0.4 |
| Security Y | 2 | 0.3 |
- Which security is defensive and why?
- Whish security has greater unsystematic risk and why?
- Which security requires more risk premium and why?
Why calculation of common stock is difficult than bonds?
Expected rate of return on market portfolio 14% T-bills yield 6% Expected return (investor) 10% calculate Beta of stock=?
How stable dividend policy could increase the marketability of a firm’s shares?
Stable dividend per share: look favorably by investors and implies low risk firm. it increases the marketability of firm’s share. Cash flow can be planned as dividend amount can be ascertained with accuracy (aid in financial planning)
Differentiate between the single period capital rationing and multi-period capital rationing.
Single period capital rationing
It is a situation where the company has limited amounts of funds in one investment period only. After that period, the company can access funds from various sources, e.g. issuing shares, borrowing from banks or issuing bonds.
Multi-period capital rationing
When capital is in limited availability in more than one period and selection of projects cannot be made by ranking projects according to PI, this situation is known as multi-period capital rationing.
Why the weighted average cost of capital of levered firm is lesser than the un-levered firm? Briefly describe
A levered firm has a lower weighted average cost of capital as compare to un-levered firm because of interest tax shield.
What is the difference between systematic and unsystematic risk?
Systematic risk
refers to the risk which affects the whole stock market and therefore it cannot be reduced or diversified away.
Unsystematic risk
is the extent of variability in the stock or security’s return on account of factors which are unique to a company.
1. Systemic and unsystematic risk
Systematic Risk:
Systematic risks are unanticipated that effects all the assets to some degree. It is nondiversifiable. Systematic risk influences large number of assets and is also known as market risk. Systematic Risk is measured by Beta Coefficient or Beta. Beta measure the systematic risk inherent in an asset relative to the market as whole.
Unsystematic Risk or Unique Risk:
It affects only specific assets or a firm. it is also known as Diversifiable or Unique or Asset- specific Risk. It can be eliminated by Diversification therefore; a Portfolio with many assets has almost zero Unsystematic Risk.
Higher rate of interest effect the capital rationing, briefly discuss.
High interest rates do not mean capital rationing. It means your capital costs are high.
Q # 2. What is capital rationing what factors effect capital rationing?
When firms have to take decisions under the constraint of fund availability it is termed as capital rationing.
Factors effect capital rationing:
- External
- Internal
- Managerial attitude
- Lack of quality manager
- Dilution of control
- Constraints put by creditors
Q # 3. An investor buys a bond that will pay the interest amount of Rs.60 annually, forever. Which of the following would be the present value of the bond if there is exactly one year remaining until the next interest payment and the investor’s required annual return is 5 percent?
Question of 5 Marks:-
Suppose you are a capital budgeting manager of a company. For current year you have a total capital budget of Rs.6,000,000. Following are given the projects available for investment:
|
Projects |
Initial Investment (millions) |
Annual Cash flows (millions) |
Project Life (years) |
Discount Rates |
|
A |
3 |
1 |
5 |
10% |
|
B |
3 |
1.5 |
3 |
8% |
|
C |
3 |
1 |
6 |
12% |
Requirement:-
Which project(s) should be selected for investment with in the given budget?
Q 3.Compare and contrast the Stable Dividend per share policy and Constant dividend payout policy.
Dividend Policies
Stable dividend per share:
look favorably by investors and implies low risk firm. It increases the marketability of firm’s share. Cash flow can be planned as dividend amount can be ascertained with accuracy (aid in financial planning)
Constant dividend payout (div per share/Eps)
A fixed %age is paid out as dividend. Under this policy the dividend amount will vary because the net income is not constant. Thus results in variability of return to investors. The dividends may drop to nil in case of loss. Market price of share will lower.
Q 4.How does the probability analysis evaluate the financial feasibility of a project?
The profitability index, or PI, method compares the present value of future cash inflows with the initial investment on a relative basis. Therefore, the PI is the ratio of the present value of cash flows (PVCF) to the initial investment of the project.
P1 = PVCF / Initial Investment
In this method, a project with a PI greater than 1 is accepted, but a project is rejected when its PI is less than 1.if the present value of cash flows exceeds the initial investment, there is a positive net present value and a PI greater than 1, indicating that the project is acceptable.
Why WACC should be used as discount rate for analyzing financial viability of Projects?
Capital Budgeting
It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm.
Popular methods of capital budgeting include net present value (NPV), internal rate of return (IRR), discounted cash flow (DCF) and discounted payback period. The discount rate used to find out the PV of future cash flow is normally the WACC.
In capital budgeting context it should be remember that WACC will only be appropriate discount rate if the proposed project has the same risk level.
(3) Calculate portfolio beta from following information
| Stock of firm Percentage of investment Betas |
| A 40% 1.2 |
| B 30% 1.4 |
| C 20% 0.8 |
| D 10% 1.1 |
(5) Why dividend policy is important for company and shareholders? Explain Briefly.
Dividend Policy
The policy a company uses to decide how much it will pay out to shareholders in dividends.
Distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders is called dividend. The dividend is most often quoted in terms of the dollar amount each share receives (i.e. dividends per share or DPS). It can also be quoted in terms of a percent of the current market price, referred to as dividend yield.
Lots of research and economic logic suggests that dividend policy is irrelevant (in theory).
If there is interest tax value? Then why should not all tax payers borrow more.
M & M model says that debt financing increases the value of firm due to tax shield.
However, there are certain aspects of high gearing that discourage borrowing. These aspects are:
Bankruptcy Costs:
As debt increases, a chance of default of repayment of principal and interest increases. Investors dislike this and will result in fall in value of firm’s securities. The interest tax shield should overweigh the bankruptcy cost.
Why market value of cost of debt and equity used in WACC instead of book value?
Because we’re interested in determining what the cost of financing the firm’s assets would be given today’s market situation and the component costs the firm currently faces, not what the historic prices would have been.
If book value weights are used instead, the higher a firm’s M/B ratio, the more WACC will be underestimated
Determinates market value of cost of debt and equity?
What is the influence of inflation on the rate of return in CAPM?
Face Value = 1020, time period = 15 years, after 1 year bond value increases to 1050. Coupon payment = Rs.80 Calculate rate of return of bond?
What is capital rationing? And discuss its basic factors.
When firms have to take decisions under the constraint of fund availability it is termed as capital rationing.
The factors for putting limit:
• Net present values or IRR may strongly influence the overall budget amount
• Top management’s philosophy toward capital spending.
• Same managers are highly growth minded whereas others are not.
• The outlook for future investment opportunities that may not be feasible if extensive current commitments are undertake.
• The funds provided by the current operations less dividends.
• The feasibility of acquiring additional capital through borrowing or sale of additional stock. Lead time and costs of financial market transactions can influence spending.
• Period of impending change in management personnel, when the status quo is maintained.
• Management attitudes toward not.
What is market risk (beta)? Briefly explain.
Market risk is measured by beta, which is another measure of investment risk that is based on the volatility of returns. In contrast to standard deviation, beta measures volatility relative to a relevant baseline rather than to the mean of the asset that is being evaluated. Beta is the appropriate measure of an asset’s contribution to your portfolio’s risk, as it measures only systematic risk, i.e., market risk.
Difference between Break even Analysis and Sensitivity analysis?
SENSITIVITY ANALYSIS:
Sensitivity analysis is the study of how the variation in the output of a model (numerical or otherwise) can be apportioned, qualitatively or quantitatively, to different sources of variation.
ECONOMIC BEAK-EVEN
The problem associated with accounting break even is that accounting earnings are calculated after the deduction of all costs except the opportunity cost of the capital that is invested in the project.
suppose we have two stocks i.e. stock A and stock B.stock A has beta of 1.5 and stock B has a beta of 0.75.The expected rate of return on average stock is 13% and the risk free rate of return is 7%.By how much does the required rate on the riskier stock exceeds the required return on the less risky stock.
The after-tax cost of debt is lower when the firm’s tax rate is higher; therefore, the weighted average cost of capital (WACC) falls when the tax rate rises. Thus, with a lower discount rate, the firm must be worth more if its tax rate is higher.” Explain why this argument is wrong?
How capital rationing can be a hurdle to choose an optimum level of capital investment.
Why capital asset pricing model (CAPM) is more suitable to calculate the cost of equity as compared to dividend growth model? Discuss.
Using dividend growth model does not mean capital gains; investors can have their income return slowly and at low risk. Many companies have been using this method. If we summarize, its major points were;
• To invest a solid share
• To increase dividends annually
• To avoid inflation and
• Additional income each year
The CAPM on the other hand, tells us that investors demand a higher rate of return for riskier shares. CAPM proposed a higher rate of risks than dividend growth model. CAPM is a model for pricing an individual’s security or a portfolio. The investor has a higher rate of risk since he invests in the form of assets. It is generally seen as a much better method of calculating the cost of equity than the dividend growth model (DGM) in that it explicitly takes into account a company’s level of systematic risk relative to the stock market as a whole.
Differentiate between a bond’s Coupon rate and its Yield to Maturity?
Yield-to-Maturity, or YTM, is the single discount rate applied to all future interest and principal payments. It will produce a present value equivalent to the price of the security. YTM is the rate of return estimated on a bond if it is held until the maturity date,The coupon rate, or, more simply stated, coupon of a particular bond, is the amount of interest paid every year. It is expressed as a percentage of the face value. Basically, it is the rate of interest that a bond issuer, or debtor, will pay to the holder of the bond. Thus, the coupon rate determines the income that will be earned from the bond.
1. YTM is the rate of return estimated on a bond if it is held until the maturity date, while the coupon rate is the amount of interest paid per year, and is expressed as a percentage of the face value of the bond.
2. YTM includes the coupon rate in its calculation.
Differentiate between accounting breakeven point and economic breakeven point.
The difference between the accounting and economic breakeven is a cost factor known as opportunity cost of capital. In accounting break even we calculate the accounting earnings first and then deduct all the costs from earnings to reach at breakeven except the opportunity cost of capital that is invested in the project.
Economic break even suggests that when you deduct other cost from accounting earnings you should also deduct the cost of capital employed. A project having a positive EVA adds value to firm and a negative EVA reduces the firm’s value
Suppose you have 40% of your portfolio invested in firm A, 30% in firm B, 20% in firm C, and 10% in firm D. You know that the betas for these firms are, respectively, 1.2, 1.4, 0.8, and 1.1. Calculate your portfolio beta.
Portfolio beta = XaBa + XbBb +XcBc + XdBd
Xa = portfolio invested in firm A
Ba = beta for firm A
Portfolio beta = (40% * 1.2) + (30% * 1.4) + (20% * .8) + (10%*1.1) = .48 + 0.42 + .16 + .11 = 1.17
Explain Systemic and unsystematic risk?
Systematic Risk:
Systematic risks are unanticipated that effects all the assets to some degree. It is non diversifiable. Systematic risk influences large number of assets and is also known as market risk. Systematic Risk is measured by Beta Coefficient or Beta. Beta measure the systematic risk inherent in an asset relative to the market as whole.
Unsystematic Risk or Unique Risk:
It affects only specific assets or a firm. it is also known as Diversifiable or Unique or Asset- specific Risk. It can be eliminated by Diversification therefore; a Portfolio with many assets has almost zero Unsystematic Risk.
Differentiate between a bond’s Coupon rate and its Yield to Maturity?
Yield-to-Maturity, or YTM, is the single discount rate applied to all future interest and principal payments. It will produce a present value equivalent to the price of the security.
YTM is the rate of return estimated on a bond if it is held until the maturity date, The coupon rate, or, more simply stated, coupon of a particular bond, is the amount of interest paid every year. It is expressed as a per cent age of the face value. Basically, it is the rate of interest that a bond issuer, or debtor, will pay to the holder of the bond. Thus, the coupon rate determines the income that will be earned from the bond.
1. YTM is the rate of return estimated on a bond if it is held until the maturity date, while the coupon rate is the amount of interest paid per year, and is expressed as a percentage of the face value of the bond.
2. YTM includes the coupon rate in its calculation.
Why capital asset pricing model (CAPM) is more suitable to calculate the cost of equity as compared to dividend growth model? Discuss.
Using dividend growth model does not mean capital gains; investors can have their income return slowly and at low risk. Many companies have been using this method. If we summarize, its major points were;
• To invest a solid share
• To increase dividends annually
• To avoid inflation and
• Additional income each year
The CAPM on the other hand, tells us that investors demand a higher rate of return for riskier shares. CAPM proposed a higher rate of risks than dividend growth model. CAPM is a model for pricing an individual’s security or a portfolio. The investor has a higher rate of risk since he invests in the form of assets. It is generally seen as a much better method of calculating the cost of equity than the dividend growth model (DGM) in that it explicitly takes into account a company’s level of systematic risk relative to the stock market as a whole.
A Company had the following data, extracted from its financial statements for the year ending June 30, 2008:
a) Current Ratio = 2
b) Acid Ratio = 1.5
c) Current Liabilities = $500,000
d) Inventor y Turnover = 5
e) Gross Profit Margin = 20 percent
What were its sales for the year?
Current ratio = current assets / current liabilities
= current assets / 500,000
Current assets = 500,000 * 2
= 1,000,000
Acid ratio = current assets / current liabilities
1.5 = current assets / 500,000
Current assets = 500,000*1.5
= 750,000
Inventory = 1,000,000 – 750,000
= 250,000
Inventory turnover = CGS / average inventory
= CGS / 250,000
CGS = 250,000 * 5
= 1,250,000
Sales = 1,250,000/.8
= 1,562,500
Bank A pays 6.2% interest compounded semiannually and Bank B pays 6%
interest, compounded monthly. Which bank off ers the higher effective annual rate?
Bank A
EAR = [1 + i/n) n – 1
= (1+6.2%/2)2-1
= (1+3.1%)2-1
= (1+0.031) 2 -1
= (1.031)2-1
= 1.06296-1
Bank B
EAR = [1 + i/n) n – 1
= (1+6%/12)12-1
= (1+.5%)12 -1
= (1+0.005)12-1
= (1.005)12 -1
= 1.06167-1
= 6.1677
Bank A offer higher effective annual rate
Calculate and compare the effective annual interest rates for Bank A and B, if Bank A is offering interest rate of 10% per year, compounded monthly. Bank B is offering interest rate of 8% per year, compounded quarterly.
BANK A (compounded monthly)
EAR = (1+i/n)n-1
= (1+.1/12)12-1
= (1.0083)12 – 1
= 1.1043 – 1
BANK B (compounded quarterly)
EAR = (1+i/n)n-1
= (1+.02)4-1
= (1.02)4 – 1
= (1.08243 -1
= 8.2432
What is the relationship between market risk of a security and rate of return that investors demand of that security?
The extra return that investors require for taking risk is known as the risk premium. The capital asset pricing model states that the expected risk premium of an investment should be proportional to both its beta and the market risk premium. The expected rate of return from any investment is equal to the risk-free interest rate plus the risk premium, so the
CAPM boils down to
r = rf + b(rm – rf )
The security market line is the graphical representation of the CAPM equation. The security market line relates the expected return investor’s demand of a security to the beta.
How much should you pay for a bond with $1,000 face value, a 14 percent coupon rate, and five years to maturity if your appropriate discount rate is 10 percent and interest is paid annually?
140/(1.10)+140/(1.10)2+140/(1.10)3+140/(1.10)4+140/(1.10)5 +1000/(1.10)5
127 + 115 + 105 + 95 + 86 + 620.92
1148
What (high or low) level of Debt Financing would you suggest for the following firms?
A) Firm paying high tax
In this case i suggest that firm should do high debt financing so firm can reduce its tax.
B) Firm paying no tax
In this case i suggest that firm should do low debt financing because firm is already not paying any tax so no need for high debt financing in this situation for the purpose of tax payment.
Capital ratio for investment
Capital Rationing occurs when a company has more amounts of capital budgeting projects with positive net present values than it has money to invest in them. Therefore, some projects that should be accepted are excluded because financial capital is limited. This is known as artificial constraint because the management may dictate the amount to be invested for project purposes.
It is also the artificial constraints because the amount is not based on the product marginal analysis in which the return for each proposal is related to the cost of capital and projects with net present values ar e accepted. A company may adopt a posture of capital rationing because it is fearful of too much growth or hesitant to use external sources of financing.
Dividend policy and types.
The policy a company uses to decide how much it will pay out to shareholders in dividends.
TYPES OF DIVIDEND
1.
Cash (most common) are those paid out in form of “real cash”. It is a form of investment interest/income and is taxable to the recipient in the year they are paid. It is the most common method of sharing corporate profits.
2.
Stock or Scrip dividends (common) are those paid out in form of additional stock shares of the issuing corporation, or other corporation (e.g., its subsidiary corporation).
They are usually issued in proportion to shares owned (e.g., for every 100 shares of stock owned, 5% stock dividend will yield 5 extra shares). This is very similar to a stock split in that it increases the total number of shares while lowering the price of each share and does not change the market capitalization
3.
Property or dividends in specie are those paid out in form of assets from the issuing corporation, or other corporation (e.g., its subsidiary corporation). Property dividends are usually paid in the form of products or services pr voided by the corporation. When paying property dividends, the corporation will often use securities of other companies owned by the issuer.
Difference b/w simple payback period and discount period?
The only difference between simple and discounted Pay Back is discounting.
Simple payback method does not care about the time-value of money principle while discounted payback period do take care of this principle in calculation.
Difference between IPO and private placement securities
Initial public offerings and private placements are types of offerings of securities for sale to investors. The key differences between the two involve government registration requirements and the potential rates of investment return.
Initial Public Offering
An initial public offering, or IPO, is a private company’s first sale of stock to the public.
Often, IPO’s are offered by smaller and younger companies that are looking to grow rapidly. That means IPO’s are a risky investment, because the company has a limited history and the stock’s future value is uncertain.
Private Placement
A private placement is a non-public offering that is typically exempt from the usual requirements of registration with the U.S. Securities and Exchange Commission. Private placements usually involve sales of securities to small groups of institutional and accredited investors. Banks, mutual funds, insurance companies and pension funds are most likely to offer private placements.
Differences
A company issuing a private placement has the advantage of not having to pay expensive underwriting fees that are common with IPO’s. Also, private placements are not traded on public exchanges, but in general their rates of return are potentially higher than those of IPO’s.
Stock A & B have beta of 1.5 & 0.75 respectively. Risk free rate is 7% & average return rate is 13%.By how much required risk of higher risky stock is greater than of lower risky stock? 5marks
Stock A
Ere = Rf + Be x (Erm – Rf)
Ere = 0.07+ 1.5 x (0.13 – 0.07)
Ere = 0.07+ 1.5 x (0.06)
Ere = 0.07+ 0.09
Ere = 0.16*100
Ere = 16%
Stock B
Ere = Rf + Be x (Erm – Rf)
Ere = 0.07+ 0.75 x (0.13 – 0.07)
Ere = 0.07+ 0.75 x (0.06)
Ere = 0.07+ 0.045
Ere = 0.115
Ere = 11.5%
The required risk of higher risky stock is 4.5% greater than lower risky stock.
Stock A is highly risky.
How PI is used in capital budgeting decisions.
The profitability index, or PI, method compares the present value of future cash inflows with the initial investment on a relative basis. Therefore, the PI is the ratio of the present value of cash flows (PVCF) to the initial investment of the project.
P1 = PVCF / Initial Investment
In this method, a project with a PI greater than 1 is accepted, but a project is rejected when its PI is less than 1.if the present value of cash flows exceeds the initial investment, there is a positive net present value and a PI greater than 1, indicating that the project is acceptable.
A company has 800,000 12% debt financing. Calculate PV of tax benefit if tax rate is 40%. By how much tax benefit would change if tax rate decreases to 30%.
PV of tax benefit = 800000*12% *40%
= 800000*.12 * .4 = 38400
If tax decrease:
PV of tax benefit = 800000*12% *30%
== 800000*.12 * .3 = 28800
Change = 38400-28800 = 9600
What are gear and UN gear beta describe the difference?
Beta Geared
The Beta attaching to the ordinary shares of a geared firm. These bear a risk higher than the firms basic activity.
Beta Ungeared
The geared Beta stripped of the effect of gearing. Corresponds to the activity Beta in an equivalent ungeared firm. The inherent systematic riskiness of a firms operations, before allowing for gearing.
Break-even analysis and sensitivity analysis explain it.
A breakeven analysis is used to determine how much sales volume your business needs to start making a profit. The breakeven analysis is especially useful when you’re developing a pricing strategy, either as part of a marketing plan or a business plan. To conduct a breakeven analysis, use this formula:
Fixed Costs divided by (Revenue per unit – Variable costs per unit)
Sensitivity analysis is used to determine how “sensitive” a model is to changes in the value of the parameters of the model and to changes in the structure of the model.
Parameter sensitivity is usually performed as a series of tests in which the modeler sets different parameter values to see how a change in the parameter causes a change in the dynamic behavior of the stocks. By showing how the model behavior responds to changes in parameter values, sensitivity analysis is a useful tool in model building as well as in model evaluation.
Suppose you have invested in two stocks A and B their betas are 1.5 and 0.75 respectively. Expected rate of return on Average stock is 13% and risk free return rate is 7%.
By how much does the required rate of return on the riskier stock exceeds the required rate on less risky stock?
Interest tax shields are valuable, why don’t all taxpaying firms borrow as much as possible.
Projects |
Initial investment |
PV of cash flows |
| W | (50000) | 65000 |
| X | (100000) | 120000 |
| Y | (85000) | 113000 |
| Z | (96000) | 105000 |
- Calculate NPV.
- Rank projects according to NPV and calculate total NPV of selected projects.