Equity

[June 2013 CFA Level 1 Group]

Use this discussion thread to ask and discuss queries related to Equity Topic.

[haidriqbal]

The value of a security market index at the end of December is 1,200. The index returns for the next six months are:

Month	Return
January	3.89%
February	8.76%
March	−4.74%
April	6.88%
May	−5.39%
June	−8.12%

The index value at the end of June is closest to:

A) 1,200.

B) 1,186.

C) 1,214.

Your answer: C was incorrect. The correct answer was A) 1,200.

The index value at the end of June is
1,200(1.0389)(1.0876)(0.9526)(1.0688)(0.9461)(0.9188) = 1,200.

Note that the compound rate of return is
(1.0389)(1.0876)(0.9526)(1.0688)(0.9461)(0.9188)−1 = 0.

Is there an easier, less time wasting way of doing this?

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[haidriqbal]

Assume a company has earnings per share of $5 and pays out 40% in dividends. The earnings growth rate for the next 3 years will be 20%. At the end of the third year the company will start paying out 100% of earnings in dividends and earnings will increase at an annual rate of 5% thereafter. If a 12% rate of return is required, the value of the company is approximately:

A) $92.92.

B) $55.69.

C) $102.80.

Your answer: C was correct!

First, calculate the dividends in years 0 through 4: (We need D₄ to calculate the value in Year 3)

D₀ = (0.4)(5) = 2
D₁ = (2)(1.2) = 2.40
D₂ = (2.4)(1.2) = 2.88
D₃ = E₃ = 5(1.2)³ = 8.64

g after year 3 will be 5%, so

D₄ = 8.64 × 1.05 = 9.07

Then, solve for the terminal value at the end of period 3 = D₄ / (k − g) = 9.07 / (0.12 − 0.05) = $129.57

Present value of the cash flows = value of stock = 2.4 / (1.12)¹ + 2.88 / (1.12)² + 8.64 / (1.12)³ + 129.57 / (1.12)³ = 2.14 + 2.29 + 6.15 + 92.22 = 102.80

This one too. I think these will go way above 1.5 min

On Tuesday, 12 February 2013 21:14:38 UTC+5, June 2013 CFA Level 1 Group wrote:

[Cern]

These 2 are questions on mock exam 2010 morning session

On first question I got the right answer but I figured it out a

different way. I just played around to get a number

by using the D/(r-g) formula. It came out to the exact same number 5.71

I guess I was lucky but I wanted to clarify in which cases I would 

use  the D/(r-g) and the (D/E)/(r-g) formula

 

2. This question I missed one extra step that I circled in red. Could you please explain more why we need this step? 

Thank you,

Cern

[Arif Irfanullah]

I can't think of a simpler method. 

You are multiplying 6 numbers on a calculator. What is hard about that?

[Arif Irfanullah]

There is a faster way of doing this on a calculator.  I'll create a video and publish in the next couple off days.

[Arif Irfanullah]

These are important concepts which you need to understand. I'll create a video  on these items and publish in the next couple of days.

[Arif Irfanullah]

Click here for a video response to Cern's questions and a practice Equity quiz.  

I hope all of you are doing a lot of practice. Make sure you also do several full length (3 hour - 120 questions) papers.  This will help develop your time management skills and build your exam-taking stamina. 

Don't worry too much if your score is not great.  Simply learn from  your mistakes and keep practicing.  If you follow this advice I'm sure you will find the actual exam easier than the mocks/practice exams.