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Dividend Payout ratio
DIVIDEND/NET INCOME


Sustainable Growth Rate (g*)
ROE*(1b) or ROE*Plowback

EARNINGS PER SHARE
NET INCOME/# SHARES OUTSTANDING

DEGREE OF COMBINED LEVERAGE (DCL)
((PRICEVC)Q)/((PRICEVS)QFCI)

break even
total fixed costs/unit contribution margin

contribution margin
(sales pricevariable cost)/sales price

Cost of Perferred Stock
PS dividend/PS price



D1
 dividend at the end of the period
 d0*(1+g)
 recently paid (1+growth rate)

Kcs
required return on common stock

g
constant annual growth rate

gordon growth model
d1/(kcsg)

preferred stock
Hybrid security: common stock and debt

hybrid security
 1) It’s like common stock: no fixed maturity.
 Technically, it’s part of equity capital.
 2) It’s like debt: preferred dividends are fixed.
 Missing a preferred dividend does not constitute default, but preferred dividends are usually cumulative.

Preferred stock
 non voting and non participating
 liquidates after debt before common stock
 dividends fixed (% of par)
 dividend/requried return

Business (operating) risk
 Variability or uncertainty associated with operating income (i.e. EBIT).
 Note: Specific industry influences business risk.

financial risk
 Risk of distress or bankruptcy due to the use of fixed cost financing.
 Note: Management influences the financial risk with VC vs. FC decisions

Break even formula
Total FC/unit contribution margin

operating leverage
With high operating leverage, a small increase in sales produces a relatively larger increase in operating income

DOL
a 1% increase in sales will result in a DOL increase in operating income(EBIT)

DOL
 salesvc/EBIT
 or
 q*(pv)/
 q*(pv)F

Financial leverage
by using fixed cost financing (i.e. debt or preferred stock), a small change in operating income is magnified into a larger change in earnings per share.

DFL
a 1% increase in operatin gincome (EBIT) results in a DFL increase in EPS (earnigns per share)

DFL Equation
 Ebit/ebit1
 or
 Q(pv)f/Q(Pv)FI

Combined Leverage
by using operating leverage and financial leverage, a small change in sales is magnified into a larger change in earnings per share.

DCL
a 1% increase in sales results in a DCL increase in EPS

DCL equation
 SalesVC/EBITI
 or
 Q(Pv)/Q(PV)FI
 Dol top/dfl bottom

how to measure risk
(variance, standard deviation, beta

How to reduce risk
diversificiation

How to price risk
security market line, CAPM

standard deviation
measure or despersion of possible outcomes

expected return
 P(k1)*K1 + p(k2)*k2) +...
 p=probabiliy
 k=expected return

variance
 sum PfirmER (^K) * K
 Pexpected return of firm * k (expect return)

standard deviation
square root of variance

Correlation of 1
 “perfect positive correlation”
 Variables move in perfect tandem

Correlation 1
 perfect negative correlation”
 Variables move in exactly opposite directions

The _______ the correlation among assets in a portfolio (i.e. closer to 1) the _______ the risk reduction possibilities for the portfolio.
The LOWER the correlation among assets in a portfolio (i.e. closer to 1) the GREATER the risk reduction possibilities for the portfolio.

Market risk/systematic risk
is also called nondiversifiable risk. This risk cannot be diversified away

Firm Specific (i.e. Nonsystematic or Idiosyncratic) Risk
is also called diversifiable risk. This risk can be reduced through diversification.

If a security is below the SML, it is
overpriced.

If a security is above the SML, it is
underpriced

market risk premium
KmKf

CAPM Equation
Kj= Krf + Bj*(KmKf)

Kj
required return on security j

Krf
riskfree rate of interest


Km
return on market index

three sources of capital
 debt: bonds, ST/LT bank loans
 preferrd stock: hybrid debt & equity
 Equity: common stock

Base equity rate
 bond yield
 equity risk premium

Micro cap equity rate
bond yield, equity risk premium, micro cap risk premium

start up firm equity rate
 bond yield
 equity risk premium
 micro cap risk premium
 liquidy (start up risk premium)

