# Growth stocks and income stocks when a corporation

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Growth stocks and income stocks When a corporation generates a positive Net Income, it uses a portion of those earnings to pay dividends to its shareholders and uses the remaining portion to reinvest back into the company with the intent to expand its operations (grow). The percentage of earnings that are paid out as dividends is referred to as the Payout Ratio, and the remaining percentage that is reinvested is referred to as the Retention Ratio. Estimating g To estimate g, we need the retention ratio and Return on Equity (ROE) where; Retention Ratio = (Net income – Dividend) / Net income ROE= Net income/Owner’s equity So, g can be calculated as follows: g = (retention ratio)*ROE = (1-payout ratio)*ROE Total value = value of assets in place + Present value of growth opportunities
NPV and Other Investment Criteria The following are ways firms determine how to evaluate investment opportunities: 1. NPV Formula: NPV = PV – Required Investment (C0) Take into consideration the opportunity cost of capital, as it is the return you give up by investing in the project. 2. IRR IRR is the rate of return that makes the NPV equal to 0 Formula: NPV = PV of Anticipated Cash Flows – Cost of Asset = 0 You can determine IRR by trial and error followed by a graph. You can determine IRR by using finance calculator. 3. Payback Period Rule Payback period is the time needed to recover the initial investment. 4. Discounted Payback Discounted payback is the time period it takes for the discounted cash flows generated by the project to cover the initial investment in the project. 5. Book Rate of Return Book rate of return equals the company’s accounting income divided by its assets. Formula: Book rate of return = Book Income/Book Assets 6. Profitability Index Pick the projects that generate the highest NPV per dollar of investment. Formula: NPV/Initial Investment (C0) Some points to note: NPV has proven to be the only reliable measure of a project’s acceptability The NPV rule can be adapted to deal with the following situations: o Mutually exclusive projects o The investment timing decision o Long vs. short-lived equipment (unequal lives) o Replacing an old machine Rules for project selection: a firm maximizes its value by accepting all positive NPV projects. With capital rationing, you need to select a group of projects which: o Is within the company’s resources o Gives the highest NPV o When capital rationing is in place, NPV by itself cannot lead you to the correct decision - you must combine NPV with the Profitability Index.
SOS: FINE 2000 Alac Kim & Yiran Li February 6 th & 7 th , 2013
Structure 1. Chapter Overview 2. Q&A about Concepts 3. Questions: 1. Basic (few) 2. Intermediate (more) 3. Advanced (few) 4. Sample Midterms
INTRO TO FINANCE Chapter 1:
Chapter 1: Overview Separation of Investment decision: Risk vs. Reward Financing decision: Capital Structure In Canada, over 80% of corporations are privately held Corp Sole-Pro Partner Ownership Shareholder Individual 2+ Liability Limited Unlimited Either Tax “Double” Income Individual Legal Fee High Low Medium Advantage Liquidity Premium Low set-up cost Strategic Gains Disadvantage Agency Problem Investor Attraction Decision Making
FINANCIAL MARKET