EXAM 3 Finance Flashcards
debt
includes all borrowing incurred by a firm, including bonds, and is repaid according to a fixed schedule of payments.
equity
consists of funds provided by the firm’s owners (investors or stockholders) that are repaid subject to the firm’s performance.
Differences between debt and equity:
voice in management, voting rights, claims on income and assets
equity holders claims on income and assets
secondary to claims of creditors, they are residual claimant, last to receive distributions
maturity difference between debt and equity
Unlike debt, equity capital is a permanent form of financing, equity has no maturity date and never has to be repaid by firm
tax treatment differences
Interest payments to a firm’s debtholders are treated as tax-deductible expenses by the issuing firm. Dividend payments to a firm’s stockholders are not tax-deductible
common stock
true owners of the firm (also known as residual owners or residual claimants), receive what is left, limited liability, expect to be paid with adequate dividends and capital gains
common stock ownership
can be privately owned by private investors to publicly owned by a broad group of investors. shares of private firms are generally not traded. large corps are publicly owned and actively traded in broker and dealer markets
common stock voting rights
each share of stock to holder to one vote in election, generally assignable votes and may be cast at the annual stockholders meeting
proxy statement
statement transferring the votes of a stockholder to another party
common stock dividends
dividends may be paid in cash or stock, not guaranteed, but expected on basis of dividend patterns of the firm. any past due dividends must be paid first before paid to preferred stockholders
preferred stock
gives holders certain privileges that make them senior to common stockholders, prior claim on earnings and assets compared to common stocks, fixed periodic dividend (%or$). most are cumulative
basic rights of preferred stockholders
specifies a fixed periodic payment (dividend), not normally given a voting right, sometimes allowed to elect one member of BOD
common stock valuation
art and science of determining what a security or asset is worth
if you own a share you can receive cash by:
- dividends
- selling the share
bonds and stocks
price of stock is present value of:
dividends-cash income
selling-capital gains
zero dividend growth model
assumes stock will pay the same dividend each year after year, it is equal to perpetuity
constant growth model
widely cited dividend valuation approach that assumes that dividends will grow at a constant rate every period
gordon model
is a common name for the constant-growth model that is widely cited in dividend valuation.
Where 𝐷_1 = expected dividend at the end of the next period;
𝑟_𝑠 = required rate of return; g = the constant dividend growth rate
variable growth model
is a dividend valuation approach that allows for a change in the dividend growth rate.
The price/earnings multiple approach
is a popular technique used to estimate the firm’s share value; calculated by multiplying the firm’s expected earnings per share (EPS) by the average price/earnings (P/E) ratio for the industry.
primary market
new-issue market (initial public offering (IPO): The first time shares are sold in the market.
From the firm’s perspective, IPO could be a bumpy ride:
It puts you under the spotlight.
It urges you to deliver the expected results as you advertised, or your stock price may drop)
secondary market
existing shares traded among investors (Exchanges. E.g., NYSE, NASDAQ.
Over the counter (OTC). A network of brokers and dealers)
dealer
maintains an inventory:
Ready to buy or sell at any time.
Think “Used car dealer”.
