Chapter 8 Flashcards
How do common stock holders have control of a firm
election of directors and
what is a proxy vote
stockholders transfer their rights to vote to another party by means of proxy
what is a proxy fight
an outside group may solicit the proxies in an effort to overthrow management and take control of the firm
What are preemptive rights
rights of current shareholders to purchase any new shares in proportion to their current holdings
protect shareholders against dilution
what is classified stock
stock that is classified into different classes (A, B, C)
what is a distinguishing characteristic between the different classes of stock
right to vote
What are the different approaches to valuing common stock
- Discount cash flow valuation
- FCF method
- Relative Valuation
What is Dt
dividend the stockholder expects to receive at the end of year t
what is D0
the most recent dividend
what is D1
the first dividend expected
what is P(hat) t
expected price of stock at the end of year t
what is P(hat) 0
estimated value of the stock today
what is P0
the current market price of the stock
for average or marginal investors P0=…
P(hat) 0
what is rs
the required rate of return on a stock
what is g
expected growth rate in dividends
When do you use the constant dividend growth model
when the firm is mature and dividends are expected to grow at a constant rate (constant g)
what is a necessary condition for the validity of the constant growth model
g must be smaller than rs
for constant growth stock the constant growth rate is equal to…
capital gain yeild
What are the conditions for a constant growth stock
- the dividend is expected to grow forever at a constant rate, g
- the stock price will also grow at the same rate
- the expected dividend yield is constant
4.the expected capital gains yield is also constant and equal to g, the dividend
- the expected total rate of return (R(hat)s) is equal to the expected dividend yield plus the expected growth rate
why are stock prices volatile?
- required return could change
- interest rates (Rrf) could change
- Risk aversion (RPm) could change
-Comany risk (beta) could change - g could change
T/F small changes in g or rs could cause large changes in the estimated price
True
Why is it not always appropriate to use constant dividend growth model
because often times companies go through life cycles and that is what the non constant growth model is for
What are the steps to estimate current stock values in a non constant growth model
- Forecast dividends for non-constant periods (ends at horizon date (N))
- Find the horizon value
- Plug inputs into NPV formula to find sum of PV
What is the FCF valuation model”
a model that does not depend on dividends and it can be applied to divisions as well as the entire firm
why would someone use FCF model instead of dividend growth model
the dividend growth model is not useful for startups and other companies that don’t pay dividends
What is FCF
free cash flow is cash flow available for distribution to all the companies investors
what is Weighted average cost of capital? (WAAC)
the overall rate of return required by companies investors
what is the value of companies operations?
PV of expected FCF, discounted at the WAAC
What are sources of corporate value?
- operations
-nonoperating assets
-marketable securities
-investment in other buisnesses
-
who has claims on corporate value
- debtholders have first claims
-then preferred stockholders
-then the rest of the stockholders
When should you use the dividend growth model?
mature company whose dividends are expected to grow steadily in the future
when should a company use dividend growth model and FCF valuation model
when a company is paying dividends but is still in the high-growth stage of its life cycle
when should a company uses FCF valuation model?
when a company has never paid a dividend, a private company or a division of a company
What is discounted cash flow valuations?
find the value of assets, given their cash flows, growth, and risk characteristics
what is relative valuation?
value assets based on how similar assets are currently priced in the market
what are the two components to relative valuation?
- value assets on a relative basis
- find similar firms
The price of a stock is a function of:
- The value of the equity in a company
- The number of shares outstanding
What are earnings multiplese
when buying a stock it is common to look at the price paid as a mulitple of the earnings per share generated by the company
when buying a buisness it is common to look at the value of the operating asset as a multiple of the operating income
what is book value or replacement value multiples
accounting estimate of a book value is influenced by the orginal price paid and accounting adjustments made since
What are revenue multiples
revenue is far less affected by accounting choices compared to earnings and book values
what are the advantages of using revenue multiples
it is easier to compare firms in different markets with different accounting systems
it is also useful in sectors composed of young companies
what are the weaknesses of sector-specific multiples?
- they cant be computed for other sectors
- it is difficult to relate them to fundamentals
What are the ratios of multiples for earnings multiples
Price/Earning Per Share
Price/Net Cash flow per share
Value/EBIT
Value/EBITDA
what are the ratios for book value multiples
price/book value
value/book value of asset
what are ratios for revenue multiples
price/sales per share
value/sales
What are the four basic steps to using multiples
- Ensure that the multiple is defined consistently and it is measured uniformly (definitional test)
- Be ware of cross-sectional distribution of multiples (descriptional test)
- Understand how fundamentals determine the multiple - analytical test
- Find the right firms for comparison - application test
multiples rule
Both numerator and denominator should be the same claim hold of the company
