Chapter 15: Stock Valuation

Question 1

A type of liability that does not exceed the initial amount a person invested into a partnership

Answer 1

Limited liability

Question 2

A constant stream of identical cash flows with no end

Answer 2

Perpetuity

Question 3

The price at which a fixed asset is expected to be sold at the end of its useful life

Answer 3

Residual value

Question 4

The annual return, which is equal to the sum of the dividends paid plus the net change in a stock’s price, divided by the beginning price of the stock or initial investment

Answer 4

Return to stockholders

Question 5

Suggested by Miller and Modigliani, that the dividend policy of a firm should not affect the current value of a stock

Answer 5

Dividend irrelevance hypothesis

Question 6

A method of evaluating a stock by attempting to measure its intrinsic value. Studies everything from the overall economy and industry conditions, to the financial condition and management of companies

Answer 6

Fundamental Analysis

Question 7

The value of a company or an asset based on an underlying perception of the value

Answer 7

Intrinsic value

Question 8

Forecasts a firm’s future earnings per share, or EPS, which is then multiplied by the P/E ratio

Answer 8

Primary target stock price

Question 9

Employs a measure, commonly the P/E ratio, for a company and similar stocks and industry peers

Answer 9

Relative Valuation

Question 10

A valuation method used to estimate the attractiveness of an investment opportunity. Uses future free cash flow projections and discounts them (most often using the WACC) to arrive at a present value which is used to evaluate the potential for investment

Answer 10

DCF Analysis

If the value arrived at through DCF is higher than current cost of the investment, the opportunity may be a good one

Question 11

A procedure for valuing the price of a stock by using predicted dividends and discounting them back to present value

Answer 11

Dividend Discount Model

If the value obtained from the DDM is higher than what shares are currently trading at, then the stock is undervalued

Question 12

This a measure of how much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment

Answer 12

Free cash flow to equity

Question 13

A firm’s operating income less expenses, taxes and changes in net working capital and investments

Answer 13

Free cash flow to firm

Question 14

A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. They do not attempt to measure a security’s intrinsic value, but instead use charts to identify patterns that can suggest future activity

Answer 14

Technical analysis

Question 15

A theory on how risk averse investors can construct portfolios in order to optimize market risk for expected returns, emphasizing that risk is an inherent part of higher reward

Answer 15

Modern portfolio theory (Portfolio Theory or Portfolio management theory)

Question 16

The degree to which stock prices reflect all available, relevant information

Answer 16

Efficient capital markets

Question 17

A calculation of a firm’s cost of capital in which each category of capital is proportionately weighted. All sources of capital are included (common stock, preferred stock, bonds and any other long term debt)

Answer 17

Weighted average cost of capital

Question 18

The value of the corporation as a whole. Calculated by adding residual value and short term assets to cash flow from operations

Answer 18

Corporate value

Question 19

Any cash made from general business transactions from the company

Answer 19

Cash flows from operations

Question 20

We subtract the value of the company’s senior liabilities, debt and preferred stock, from the enterprise or corporate value to get this

Answer 20

Value to common equity

Question 21

Because of a competitive advantage, the company may be able to earn returns on new investments that are greater than its cost of capital during this period

Answer 21

Excess return period

Question 22

Investments into working capital, which is made up of current assets in excess of current liabilities

Answer 22

Working capital investment

Question 23

Investment into fixed assets such as property, plant and equipment

Answer 23

Fixed capital investment

Question 24

The minimum rate of return, determined with the markets current long term risk free rate of interest

Answer 24

Base rate of return

Question 25

The risk that payments of interest or principal on bonds may not be made, or the risk that dividend payments to preferred shareholders may not be made

Answer 25

Risk of default

Question 26

A measure of the volatility or systematic risk of a security or a portfolio in comparison to the market as a whole

Answer 26

Specific risk (beta or beta coefficient)