LOS 50h Calculate the effective tax rate on a dollar of corporate earnings
Dividends paid in the United States are taxed according to what is called a double-taxation system. Earnings are taxed at the corporate level regardless of whether they are distributed as dividends, and dividends are taxed again at the shareholder level. In 2003, new tax legislation was passed in the U.S. that reduced the maximum tax rate on dividends at the individual shareholder level from 39.6 to 15 . Since a dollar ot earnings distributed as dividends is the first taxed at the corporate...
LOS 48e Explain the marginal cost of capitals role in determining the net
One cautionary note regarding the simple logic behind Figure 1 is in order. All projects do not have the same risk. The WACC is the appropriate discount rate for projects that have approximately the same level ot risk as the firm's existing projects. This is because the component costs of capital used to calculate the firm's WACC are based on the existing level of firm risk. To evaluate a project with greater than the firm's average risk, a discount rate greater than the firm's existing WACC...
LOS 47f Describe the relative popularity of the various capital budgeting
Despite the superiority of NPV and IRR methods tor evaluating projects, surveys of corporate financial managers show that a variety ot methods are used. The surveys show that the capital budgeting method used by a company varied according to four general criteria Location. European countries tended to use the payback period method as much or more than the IRR and NPV methods. Size of the company. The larger the company, the more likely it was to use discounted cash flow techniques such as the...
LOS 50g Summarize the factors affecting dividend payout policy
A company's dividend payout policy is the approach a company follows in determining the amount and timing ot dividend payments to shareholders. Six primary factors affect a company's dividend payout policy Signaling effect. Unexpected changes in a company's dividend policy are often viewed by investors as a signal from management about projections of the firm's future performance. In other words, stockholders perceive changes in dividend policy as conveying important information about the firm....
The Relative Advantages and Disadvantages of the NPV and IRR Methods
A key advantage of NPV is that it is a direct measure of the expected increase in the value of the firm. NPV is the theoretically best method. Its main weakness is that it does not include any consideration of the size of the project. For example, an NPV ot 100 is great for a project costing 100 but not so great tor a project costing 1 million. A key advantage of IRR is that it measures profitability as a percentage, showing the return on each dollar invested. The IRR provides information on...
Study Session 11
47. Capital Budgeting, John D. Stowe and Jacques R. Gagn CFA Institute, 2006 Page 48. Cost of Capital, Yves Courtois, Gene C. Lai, and Pamela P. Peterson CFA 49. Capital Structure and Leverage, Raj Aggarwal, Cynthia Harrington, Adam Kohor, and Pamela P. Peterson CFA Institute, 2006 page 42 50. Dividends and Dividend Policy, George H. Troughton and Catherine E. Clark 51. The Corporate Governance of Listed Companies A Manual for Investors, CFA
LOS 49a Define and explain leverage business risk sales risk operating risk and
Leverage, ill the sense we use it here, refers to the amount ot fixed costs a firm has. These fixed costs may be fixed operating expenses, such as building or equipment leases, or fixed financing costs, such as interest payments on debt. Greater leverage leads to greater variability ot the turn's atter-tax operating earnings and net income. A given change 11 sales will lead to a greater change in operating earnings when the firm employs operating leverage a given change in operating earnings...
LOS 48d Explain the analysts concern with the marginal cost of capital in
A company increases its value and creates wealth tor its shareholders by earning more on its investment in assets than is required by those who provide the capital tor the firm. A firm's WACC may increase as larger amounts of capital are raised. Thus, its marginal cost of capital, the cost of raising additional capital, can increase as larger amounts are invested in new projects. This is illustrated by the upward sloping marginal cost of capital curve in Figure 1. Given the expected returns...
Unlimited Funds Versus Capital Rationing
It a firm has unlimited access to capital, the firm can undertake all projects with expected returns that exceed the cost ot capital. Many firms have constraints on the amount of capital they can raise, and must use capital rationing. If a firm's profitable project opportunities exceed the amount of funds available, the firm must ration, or prioritize, its capital expenditures with the goal ot achieving the maximum increase in value for shareholders given its available capital.
Study Session 14 1
The topical coverage corresponds with the following CFA Institute assigned reading 59. An Introduction to Security Valuation a. explain the top-down approach, and its underlying logic, to the security valuation process, page 160 b. explain the various forms of investment returns, page 161 c. calculate and interpret the value of a preferred stock, or of a common stock, using the dividend discount model DDM . page 161 d. show how to use the DDM to develop an earnings multiplier model, and explain...