Question 1

An emerging firm can be described as 'investment ready' when it:

Accepted Answer

An emerging firm that is 'investment ready' should have all of these characteristics - substantial size, effective management structure, capable of preparing regular financial reports and a track record of profitable operations. Having all of these characteristics makes the firm more attractive to potential investors and increases the likelihood of securing investment.

Question 2

Venture capital is best defined as:

Accepted Answer

Venture capital is typically used to provide equity capital (ownership) to new and emerging businesses with high growth potential. This funding is often used in the early stages of the business when the company may not have sufficient collateral to obtain traditional debt financing. Venture capitalists provide funding in exchange for a percentage of ownership in the company and often take an active role in the management and growth of the business.

Question 3

A difference between ordinary and preference shares is:

Accepted Answer

Preference dividends are typically a fixed amount or a fixed percentage of the par value, unlike ordinary dividends, which can vary depending on the company's profitability.

Question 4

The process of attempting to calculate the true value of a company's shares from their expected future dividends is best described as:

Accepted Answer

The process of attempting to calculate the true value of a company's shares from their expected future dividends is known as fundamental analysis. This involves analyzing a company's financial statements, industry trends, management, and other factors to determine its intrinsic value. Technical analysis, on the other hand, involves using past market data to predict future price movements. Behavioral finance studies how psychological biases and emotions can affect investment decisions. The top-down approach involves analyzing broad economic trends and then evaluating individual stocks. The bottom-up approach involves analyzing individual companies first and then evaluating their performance within their industry and the broader market.

Question 5

In reference to preference shares, 'non-participating' means that a holder of such shares:

Accepted Answer

Non-participating preference shares do not participate in bonuses such as special dividends or bonus shares, but they still receive a fixed dividend payment. They may or may not be able to vote at the annual general meeting, and they cannot convert them into ordinary shares. However, they do not miss out on any missed dividend payments.

Question 6

Ordinary shares:

Accepted Answer

Ordinary shares are perpetual, which means they have no fixed maturity date, and transferable, which means they can be bought and sold on stock exchanges. They provide limited liability to the shareholders, meaning their liability is limited to their investment in the company. Ordinary shares also give shareholders the right to vote in the company's annual general meetings and elect the board of directors. Lastly, ordinary shares entitle shareholders to participate in the profits of the company in the form of dividends.

Question 7

Dividend reinvestment schemes increase a company's retained earnings.

Accepted Answer

Dividend reinvestment schemes typically involve shareholders using their dividend payouts to purchase additional shares of the company's stock, rather than the company retaining earnings. This does not increase the company's retained earnings, as the dividends are still distributed out of the earnings, albeit reinvested by shareholders.

Question 8

The maximum loss possible on an investment in shares can exceed 100% when the shares are:

Accepted Answer

When shares are partly paid, the investor may be liable to pay the remaining amount on the shares if the company calls for it, leading to a potential loss exceeding the initial investment.

Question 9

According to the capital asset pricing model (CAPM), which of the following is NOT relevant to the required return for a firm's equity?

Accepted Answer

According to the CAPM, the required return for a firm's equity is based on the risk-free rate, the market return on a diversified equity portfolio, and the beta of the share. The standard deviation of returns for the firm's equity is a measure of the stock's volatility and is not directly relevant to determining the required return.

Question 10

Say that for a number of years a company's share price was around $24 and its earnings per share approximately $2.You determine that its earnings are likely to increase to $2.50 per share this period for various reasons.Which statement is correct?

Accepted Answer

The P/E ratio initially is 12 ($24 share price divided by $2 earnings per share). If earnings increase to $2.50 and the P/E ratio remains stable at 12, the share price would indeed be expected to move to $30 (12 * $2.50). Making a buy recommendation could be reasonable if you believe the earnings increase will positively affect the share price, assuming all other factors remain constant. Thus, if the change in earnings is seen as permanent, all the statements are logically connected and correct.

Question 11

A 'business angel':

Accepted Answer

A business angel is someone who invests their own money in a startup or small business and provides mentorship and support in addition to funding. They are often described as patient investors because they understand that startups may take time to become profitable and are willing to wait for a return on their investment.

Question 12

In Gordon's dividend growth model, the estimated share value is:

Accepted Answer

According to Gordon's dividend growth model, the estimated share value is positively related to the current annual dividend. This model assumes that the dividend will continue to grow at a constant rate, so the expected future dividend payments are discounted back to their present value using the required return on the share. But the value of the share also depends on the current annual dividend, as it provides a baseline for future growth. Therefore, an increase in the current annual dividend will lead to an increase in the estimated share value.

Question 13

Listed companies can make private placements of shares, as an alternative to small rights issues.

Accepted Answer

Listed companies can make private placements of shares as an alternate method of raising capital. This involves selling shares to a restricted group of investors rather than offering them to the general public via a rights issue.

Question 14

Payments to suppliers of equity:

Accepted Answer

Payments to suppliers of equity, such as dividends, are more risky than payments to debt holders because they are not a binding commitment and are paid out of profits after all other obligations, including debt payments, have been met. Equity payments do not have the highest payment priority, are not tax deductible, and do not represent a lower cost of funds than debt.

Question 15

Rights issues are used when a company requires a substantial amount of new equity capital.

Accepted Answer

Rights issues are a way for companies to raise a significant amount of new equity capital by offering existing shareholders the right to purchase new shares at a discounted price. This allows the company to raise funds without diluting the value of existing shares or taking on additional debt.

Question 16

A P/E ratio for a firm that is higher than the industry average may indicate:

Accepted Answer

A higher P/E ratio compared to the industry average signifies that investors are willing to pay more for each dollar of the firm's earnings, indicating that the stock is relatively more expensive. Therefore, D is the correct choice. A is incorrect because a high P/E ratio indicates that investors are willing to pay more for the firm's earnings, which suggests that the firm's growth prospects are seen as being above its competitors. B and C are also incorrect because they assume that a high P/E ratio implies that the stock is either underpriced or overpriced, which is not necessarily true.

Question 17

Where rights are renounceable, their price moves in response to movements in the share's (ex-rights)price.

Accepted Answer

When a company offers renounceable rights, the price of those rights is typically closely tied to the price of the underlying shares. As the share price goes up or down, so too will the price of the renounceable rights.

Question 18

An initial public offering:

Accepted Answer

An initial public offering (IPO) is the process of offering shares of a private corporation to the public in a new stock issuance. It can raise additional equity funds for the business, is the initial sale of shares to the public, is also known as a 'float', and is the process by which shares become listed on the ASX. Therefore, all of these statements are true.

Question 19

An accelerated rights issue has two parts, an accelerated issue to retail investors and a non-accelerated offer to institutional investors.

Accepted Answer

An accelerated rights issue typically involves an accelerated offer to institutional investors first, followed by a traditional rights issue to retail investors.

Question 20

Gordon's dividend growth model requires a number of variables to be estimated.The variable about which there is the greatest uncertainty is:

Accepted Answer

The variable with the greatest uncertainty in Gordon's dividend growth model is the growth rate (g). Estimating the growth rate is difficult as it depends on various factors such as the economic environment, company-specific factors, and industry trends. It requires making assumptions about the company's future prospects and the growth potential of its earnings and dividends. Hence, g is the most uncertain variable in the model.

Quiz 9: Shares