ch 7 - Stocks

Question 1

What are three models used to estimate value of future cash flows of share of stock?

Answer 1

1. single period model for preferred and common stock
2. constant growth Gordon Growth) model fo rmature firms
3. two-state model for younger or growth companies’ common stock

Question 2

what does the value of preferred stock result tell you?

Answer 2

the maximum you should be willing to pay for a stock. Any higher price would yield rate of return lower than the rate of return needed

Question 3

what is another word for discount rate

Answer 3

required rate of return

Question 4

what is are primary assumptions of the single holding period model?

Answer 4

1. investor buys a stock today, holds it for one year and then sells it in the market
2. investor generates a return from dividends and an increase in price of stock (capital gain)

Question 5

What is the key word that indicates you should use the Gordon Growth model?

Answer 5

indefinitely

Question 6

what is a downfall of the single period holding model?

Answer 6

it requires as one of its inputs the price of the stock in one year in order to calculate the price today

Question 7

What is the shortfall of the Gordon Growth Model?

Answer 7

It assumes and is limited to a constant growth rate indefinitely

Question 8

what is stage 1 of the mutli-growth model known as?

Answer 8

super-normal period

Question 9

information needed for two-stage growth model?

Answer 9

1. growth rate during super-normal growth period
2. industry average growth rate
3. length of the super-normal growth period
4. required return
5. recent dividend