Chapter 9 Flashcards
What is enterprise value (EV)?
EV = Market value of equity + Market value of debt - Cash.
What is the retention ratio formula?
Retention ratio = 1 - Dividend payout ratio.
What does the P/E ratio measure?
How much investors are willing to pay per dollar of earnings.
Does preferred stock typically have voting rights?
No, preferred shareholders generally don’t vote.
What is the formula for valuing a constant growth stock?
PV = D₁ / (r - g), where D₁ = next year’s dividend.
Why is preferred stock considered “debt in disguise”?
It pays fixed dividends and has a priority claim, like debt.
What is the value of any asset based on?
The present value of its expected future cash flows.
What is a terminal value in stock valuation?
The present value of all future cash flows beyond a forecasted period.
What is differential growth in dividends?
Dividends grow at different rates initially, then settle to a constant rate.
What are the two main components of stock cash flows?
Dividends and capital gains.
What method do many CFOs use to value their stock?
Discounted Cash Flow (DCF) and comparables, especially P/E ratios.
What is the formula for D₁ if D₀ is known?
D₁ = D₀ × (1 + g)
What does EBITDA stand for?
Earnings Before Interest, Taxes, Depreciation, and Amortization.
Why do analysts use the retention ratio and ROE to estimate growth?
Because retained earnings drive future dividend growth.
What does straight voting mean?
Shareholders must vote their shares one-for-one for each director position.
How is the growth rate (g) estimated in DGM?
g = Retention ratio × Return on retained earnings (ROE).
What is the main difference in cash flow rights between common and preferred stock?
Preferred stock has fixed dividends; common stock dividends vary and are not guaranteed.
What is a stated liquidating value in preferred stock?
The amount paid to preferred shareholders during liquidation.
What does a high P/E ratio generally indicate?
Growth expectations or potentially overvalued stock.
What does the EV/EBITDA ratio measure?
It reflects the total firm valuation relative to cash flows.
What are the three steps in valuing differential growth stocks?
Estimate future dividends, calculate horizon value, discount all to present.
What is proxy voting?
Allowing someone else to vote on your behalf in shareholder meetings.
What is the formula using P/E to value a stock?
Stock value = EPS × P/E ratio.
Are preferred stock dividends guaranteed?
No, they can be deferred, but are usually cumulative.
What is the P/E ratio used for?
Valuing equity based on earnings per share.
What is the preemptive right in common stock?
The right to maintain proportional ownership in future stock issues.
What are common stockholders’ rights?
Voting, dividends, assets on liquidation, preemptive rights.
What is a major issue when g = r in the constant growth model?
The formula becomes undefined (denominator = 0).
What does it mean if preferred stock is cumulative?
Missed dividends must be paid before any common dividends.
What financial metric is used with enterprise value ratios?
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
What does the dividend discount model (DDM) assume about dividends?
That they are the main source of value from a stock.
What is the formula for valuing a zero-growth stock?
PV = Dividend / Discount rate.
Why might the DDM not apply to certain companies?
Some firms do not pay dividends, or their dividends are unpredictable.
What are comparables used for in stock valuation?
To estimate a firm’s value using ratios from similar companies.
What are cumulative voting rights?
Shareholders can allocate all votes to one or more candidates.
What is the enterprise value-to-EBITDA ratio used for?
Valuing the overall firm instead of just equity.
In the constant growth model, what happens if g ≥ r?
The model breaks down; price becomes infinite or undefined.
What is a key feature of preferred stock dividends?
They must be paid before common stock dividends.
What is a horizon or terminal value in differential growth models?
The estimated price of the stock when it enters constant growth.
What makes estimating stock value difficult using DGM?
It requires estimating r and g, which involve uncertainty.
