Question

1. Briefly explain what you understand by Earnings per share (EPS). How is EPS calculated and why it is important for investors to gauge the value of a share? Refer to the relevant web links that I have put on course website and use any other references that you like. (Your answer should not exceed 250 words)
2. Why do firms buy back the shares from investors? What do they gain? Briefly explain the economics of such a decision and its effects on value of a firm. Refer to the relevant web links that I have put on course website and also do your own research. (Your answer should not exceed 250 words).
3. What are price earnings (PE) ratios? Refer to the notes on PE ratios that I have added on course website and also do your own research on internet. (Your answer should not exceed 250 words).
4. What is the meaning of cost of equity? Who pays this cost of equity and to whom? How do you calculate the cost of equity (use any formulas from Chapter 4 which are also given in my Power Point slides already posted on E-learning). (Your answer should not exceed 250 words).
5. What is a bond? Who issues bonds and why? Who buys bonds and why?   (Your answer should not exceed 200 words).
6. What determines the value of a bond? Write down the formula for determining the price of the bond and explain it briefly. To answer this refer to Chapter 3 of Brealey and Myers course textbook or any other reference you like which gives the same information with the same rigor.

Answer 1

1) Earnings per share :
Earnings per share or EPS is an important financial measure, which indicates the profitability of a company. It is calculated by dividing the company’s net income with its total number of outstanding shares. It is a tool that market participants use frequently to gauge the profitability of a company before buying its shares. Basically it is the amount of companies profit that is allocated to every individual shareholder of the company.

Earnings per share can be calculated in two ways:

a) Earnings per share: profit after Tax/Total Number of Outstanding Shares

b) Weighted earnings per share: (Net Income after Tax - Total Dividends)/Total Number of Outstanding Shares

• It is a tool that market participants use frequently to gauge the profitability of a company before buying its shares.. The higher the EPS of a company, the higher is its profitability.

2) A company may buy back shares to reduce its cost of capital which means replacing equity financing with more cost effective debt financing. Buy Back of shares means the issuing company intends to repurchase some or all of the outstanding shares originally issued to raise capital

• stock buybacks help the company to consolidate ownership
• company use buyback to increase its equity vlue
• to look more financially healthy and attract more investors

In order to reduce financial burden in the form of equity funding and payment of dividends company wants to refund shareholders investments.This will help in reducing Average cost of capital. High level companies who are at dominate position may buy back as they may feel that there is no room left for growth, thus large capital reserves are not required. The company may buyback to capitalize the undervalued shares

3)

.  The Price Earnings Ratio (P/E Ratio) is the relationship between a company's stock price and earnings per share.

P/E ratio is calculated by using the following formula

PE Ratio = Share Price/ Earnings per share

The Price Earnings Ratio (P/E Ratio) is the relationship between a company's stock price and earnings per share.
It indicates the amount an investor can expect to invest in company in order to receive company's earnings. It is one of the widely used amongst investors and analysts. It reveals whether stock is overvalued or undervalued. It helps in determining the market value of a stock as compare to its earnings. If PE is higher than the industry average, then stock is considered as overvalued vice versa.

4)

  Cost of Equity is the rate of return a company pays out to equity investors. A firm uses cost of equity to assess the relative attractiveness of investments, including both internal projects and external acquisition opportunities. Companies typically use a combination of equity and debt financing, with equity capital being more expensive.

The cost of equity is paid to the investor who invest in the organisation and the firm is the authority to pay on investment to the investors

Cost of equity = (next year annual dividend / current stock price ) + dividend growth rate

5) A bond is a long term debt instrument or security . the bond has a face value , interest rate , maturity, redemption value and market value .

bonds are issued by corporations, banks, governments and municipalities. Hence, the entities then opt for raising the fund through bonds (debt). Based on the size of the companies, cash flow of the companies and other parameters; the interest rate offered by the issuer can vary. Also, bonds provide tax benefit which reduces the cost of funding.

Bonds are purchased by financial institutions, pension funds, banks, insurance companies, other country governments. Bonds provide a consistent cash flow as return and they have the visibility of cash outflow.