It is a rate of return that convinces investors make an investment, especially long-term investment decisions (Da, Guo and Jagannathan, 2012). Moreover, since the cost of equity does involve the expectations of the market, it generally will be harder to measure. The other widely used method to calculate the cost of equity is by using the Gordon’s Growth Model (also known as the Dividend Discount Model). It calculates the fundamental value of today’s stock, based on the stock’s expected future dividends (Farrell, 1985). The dividend discount model focuses strictly at the future dividends as the sum of cash flows discounted by investors required rate of return and expected growth of dividend.
Another disadvantage is that their capital market is expected to be constantly perfect when this can change. Another disadvantage is that there is full pay outs, meaning that the net earnings that are paid out to their shareholders are needed to be paid out in full. Lastly the risk of estimates, meaning that when estimating the earnings to be paid out may end up fluctuating or not turning out as what the investors expected. M&M’s model is based on confident assumptions. This model’s assumptions are that, the capital markets are perfect, meaning that no investor can influence the market value of a company’s shares.
CAPITAL MARKET THEORY The Concept of Capital Market Theory is that it tries to describe and evaluate the advancement of capital and likewise financial market over a certain period of time. The Capital Market Theory in general tries to clearly define and foresee the development and advancement of capital. It is also known to be a common term that is used for the study of securities. In terms of the relationship between rate of returns seeked by all investors and likewise the inheritance of risk that comes along. The main purpose of this capital market theory model is that seeks to “price assets” but more popularly “shares” among investors.
QTM is expressed by the Fisher equation as: MV=PT 1. M is the money supply; the amount of money of an economy. 2. V is the velocity of money circulation, which is the approximate number of times money changed hands. Fisher claimed it to be constant in the short term.
Return on equity (ROE) Return on equity ratio is a measure of profitability that calculates how many profit a company generates with each dollar of shareholders' equity. This ratio compares the amount of the profit for the period available to owners with
Fixed percentage ratio is when the company pays out a fixed percentage of annual profits as dividends. The advantage of this policy from the company’s point of view is that it is relatively easy to operate and also this sends a clear signal to investors about the level of the company’s performance. The disadvantage however for the company is that it imposes a constraint on the amount of funds it is able to retain for reinvestment. Next just like the name itself zero dividend policy is when a company decides to pay no dividend at all. Such a policy is easy to operate and will not incur the administration costs associated with paying dividends.
Financial ratios: a percent, rate, or proportion that expresses a mathematical relationship between two financial quantities Liquidity ratios: evaluates how quickly a company can convert short-term assets and liabilities into cash Current ratio: evaluates a company’s ability to pay its short-term debt (current liabilities) Comparing financial data: examining financial data from multiple years to see trend lines for key measures such as net income, revenues, cost of goods sold, operating expenses, and gross margin Acid-test ratio: a more conservative liquidity ratio that evaluates how quickly cash, short-term investments, and accounts receivable can be converted into cash Inventory turnover: how long a company holds onto its services or products (inventory) Profitability ratios: measurements which reflect a company’s ability to use its assets efficiently to produce profits Return on sales/profit margin: provides insight into how efficiently and profitably a company is being run, determined by dividing net income after taxes by net sales Ratio analysis: using comparisons to gather information and see trends Basic earnings per
The Quantity theory of money states the direct relationship which exists between money supply and prices in the economy. It says that as money supply in the economy changes, price changes in the same direction too. That is if money supply increases, consumers will have more money in hand to spend, thereby demanding the more goods and services which shifts the demand curve to the left, keeping supply constant leading to a rise in the price level. In similar context when money supply falls, the price level decreases too. The Quantity theory of money is represented by the following equation: MV = PT M = Money supply V = Velocity of Circulation P = Price Levels T = Transactions T represents the total no.
To what extent is NPV an effective Investment appraisal tool? Capital Budgeting: To understand the value of NPV, the identification of its purpose in capital budgeting should be addressed beforehand, with its alternatives. This process of Capital Budgeting refers to the evaluation of potential in large scale business expenses and investments over long-term ventures. Often this step in the investment appraisal assessment, identifies the cashflows over the projects life-span, determining its generated returns in comparison to the organisations benchmark targets. (Book) Flowton’s options of replacing its older systems (Project A) or upgrading them to a centrally controlled platform (Project B) are considered such a venture.
The growth rates (of income and cash) and risk levels (to determine the discount rate) are used in various valuation models. The foremost is the discounted cash flow model, which calculates the present value of the future dividends received by the investor, along with the eventual sale price; (Gordon model) earnings of the company; or cash flows of the