Question 50 DDM, stock pricing, inflation, real and nominal returns and cash flows
Most listed Australian companies pay dividends twice per year, the 'interim' and 'final' dividends, which are roughly 6 months apart.
You are an equities analyst trying to value the company BHP. You decide to use the Dividend Discount Model (DDM) as a starting point, so you study BHP's dividend history and you find that BHP tends to pay the same interim and final dividend each year, and that both grow by the same rate.
You expect BHP will pay a $0.55 interim dividend in six months and a $0.55 final dividend in one year. You expect each to grow by 4% next year and forever, so the interim and final dividends next year will be $0.572 each, and so on in perpetuity.
Assume BHP's cost of equity is 8% pa. All rates are quoted as nominal effective rates. The dividends are nominal cash flows and the inflation rate is 2.5% pa.
What is the current price of a BHP share?
Question 99 capital structure, interest tax shield, Miller and Modigliani, trade off theory of capital structure
A firm changes its capital structure by issuing a large amount of debt and using the funds to repurchase shares. Its assets are unchanged.
Assume that:
- The firm and individual investors can borrow at the same rate and have the same tax rates.
- The firm's debt and shares are fairly priced and the shares are repurchased at the market price, not at a premium.
- There are no market frictions relating to debt such as asymmetric information or transaction costs.
- Shareholders wealth is measured in terms of utiliity. Shareholders are wealth-maximising and risk-averse. They have a preferred level of overall leverage. Before the firm's capital restructure all shareholders were optimally levered.
According to Miller and Modigliani's theory, which statement is correct?
The US firm Google operates in the online advertising business. In 2011 Google bought Motorola Mobility which manufactures mobile phones.
Assume the following:
- Google had a 10% after-tax weighted average cost of capital (WACC) before it bought Motorola.
- Motorola had a 20% after-tax WACC before it merged with Google.
- Google and Motorola have the same level of gearing.
- Both companies operate in a classical tax system.
You are a manager at Motorola. You must value a project for making mobile phones. Which method(s) will give the correct valuation of the mobile phone manufacturing project? Select the most correct answer.
The mobile phone manufacturing project's:
Bonds X and Y are issued by the same company. Both bonds yield 10% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.
The only difference is that bond X pays coupons of 6% pa and bond Y pays coupons of 8% pa. Which of the following statements is true?
Find the sample standard deviation of returns using the data in the table:
| Stock Returns | |
| Year | Return pa |
| 2008 | 0.3 |
| 2009 | 0.02 |
| 2010 | -0.2 |
| 2011 | 0.4 |
The returns above and standard deviations below are given in decimal form.
A managed fund charges fees based on the amount of money that you keep with them. The fee is 2% of the start-of-year amount, but it is paid at the end of every year.
This fee is charged regardless of whether the fund makes gains or losses on your money.
The fund offers to invest your money in shares which have an expected return of 10% pa before fees.
You are thinking of investing $100,000 in the fund and keeping it there for 40 years when you plan to retire.
What is the Net Present Value (NPV) of investing your money in the fund? Note that the question is not asking how much money you will have in 40 years, it is asking: what is the NPV of investing in the fund? Assume that:
- The fund has no private information.
- Markets are weak and semi-strong form efficient.
- The fund's transaction costs are negligible.
- The cost and trouble of investing your money in shares by yourself, without the managed fund, is negligible.
Which firms tend to have low forward-looking price-earnings (PE) ratios? Only consider firms with positive PE ratios.
You deposit money into a bank. Which of the following statements is NOT correct? You:
A stock's returns are normally distributed with a mean of 10% pa and a standard deviation of 20 percentage points pa. What is the 90% confidence interval of returns over the next year? Note that the Z-statistic corresponding to a one-tail:
- 90% normal probability density function is 1.282.
- 95% normal probability density function is 1.645.
- 97.5% normal probability density function is 1.960.
The 90% confidence interval of annual returns is between: