Chapter 9 Flashcards
1
Q
Facts About Common Stock
A
- Represents ownership
- Ownership implies control
- Stockholders elect directors
- Directors elect management
- Management’s goal: Maximize the stock price
2
Q
Intrinsic Value and Stock Price
A
- In equilibrium we assume that a stock’s price equals its intrinsic value
- Outsiders estimate intrinsic value to help determine which stocks are attractive to buy and/or sell
- Stocks with a price below (above) its intrinsic value are undervalued (overvalued)
3
Q
Discounted Dividend Model
A
- Value of stock is PV of future dividends expected to be generated by the stock
- p0=D1/(1+r)^s
4
Q
Constant Growth Rate
A
- Expected to grow at a constant rate forever
- D1=D0(1+g)^1
- D2=D1(1+g)^2
- Dt=D0(1+g)^t
5
Q
D0
A
Dividend today
6
Q
If g > rs…
A
The constant growth formula leads to a negative stock price, which does not make sense
7
Q
(rm-rrf)
A
Market risk premium
8
Q
Beta
A
Risk of investment
9
Q
Beta=1.0
A
Stock moves with the market
10
Q
Beta>1.0
A
More volatile
11
Q
Beta<1.0
A
Less volatile
12
Q
Dividend Yield
A
D1/P0
13
Q
Capital Gains Yield
A
(P1-P0)/P0
14
Q
Total Return (Rs)
A
Dividend Yield+Capital Gains Yield
15
Q
If g=0, the dividend stream is a…
A
- Perpetuity
- PMT/r
16
Q
Horizon Date
A
The date when the growth rate becomes constant; no longer necessary to forecast individual dividends
17
Q
Corporate Valuation Model
A
Value of entire firm equals present value of firm’s free cash flow
18
Q
Issues Regarding Corporate Valuation Model
A
- Often preferred to the discounted dividend model, especially when considering number of firms that don’t pay dividends or when dividends are hard to forecast
- Similar to discounted dividend model, assumes at some point free cash flow will grow at a constant rate
- Horizon value (HVN) represents value of firm’s operations at the point that growth becomes constant
19
Q
Preferred Stock
A
- Hybrid security
- Preferred stockholders receive a fixed dividend that must be paid before dividends are paid to common stockholders
- Companies can omit preferred dividend payments without fear of pushing the firm into payments without fear of pushing the firm into bankruptcy
