I have some questions for Level 1 for anyone who can help.
1.) So the discounted cash flow approach to cost of retained earnings is Ks = D1/P0 + g, where g = retention of net income divided by ROE. Aren't we mixing apples and oranges here? We've got a market-based number (Dividend Yield (stemming from a stock's market value)) blended with a book value (ROE). Am I to assume that the P0 piece is measured at cost? If not, how does this jive toward something helpful?
2.) When we compare projects with unequal lives, one method is the replacement chain method. Since the IRRs of the projects remain constant, why would I bother calculating a revised NPV for each project? Why wouldn't I just go with the better IRR?
3.) Say a company sells 10 million widgets at $10/widget, they have $3/unit variable costs and $50 million in fixed costs. DOL = change in EBIT/change in Sales, or DOL = (Q(P-V))/((Q(P-V))-F). Using the latter method, DOL = (10 million(10-3))/((10 million(10-3))-50 million) = 70 million / 20 million = 3.5.
Now let's try the first method. Say sales drop to 80 million = Sales2. EBIT2 = 80 million - ($3 * 8 million) - $50 million = $6 million. Ebit1 is unchanged = 100 million -($3 * 10 million) - $50 million = 20 million.
DOL = (EBIT1 - EBIT2)/(Sales1-Sales2) = (20-6)/(100-80) = 14/20 = .7
.7 does not equal 3.5. What am i doing wrong?
1.) So the discounted cash flow approach to cost of retained earnings is Ks = D1/P0 + g, where g = retention of net income divided by ROE. Aren't we mixing apples and oranges here? We've got a market-based number (Dividend Yield (stemming from a stock's market value)) blended with a book value (ROE). Am I to assume that the P0 piece is measured at cost? If not, how does this jive toward something helpful?
2.) When we compare projects with unequal lives, one method is the replacement chain method. Since the IRRs of the projects remain constant, why would I bother calculating a revised NPV for each project? Why wouldn't I just go with the better IRR?
3.) Say a company sells 10 million widgets at $10/widget, they have $3/unit variable costs and $50 million in fixed costs. DOL = change in EBIT/change in Sales, or DOL = (Q(P-V))/((Q(P-V))-F). Using the latter method, DOL = (10 million(10-3))/((10 million(10-3))-50 million) = 70 million / 20 million = 3.5.
Now let's try the first method. Say sales drop to 80 million = Sales2. EBIT2 = 80 million - ($3 * 8 million) - $50 million = $6 million. Ebit1 is unchanged = 100 million -($3 * 10 million) - $50 million = 20 million.
DOL = (EBIT1 - EBIT2)/(Sales1-Sales2) = (20-6)/(100-80) = 14/20 = .7
.7 does not equal 3.5. What am i doing wrong?