P2B.2 Long Term Financial Management - Common & Preferred Stock

Question 1

Common Stock Characteristics

Answer 1

1. Residual ownership of company
2. Voting power
3. Pre-emptive rights: preference to buy shares for new issues.
4. Irregular dividend distribution
5. Capital appreciation: stocks appreciate in value
6. Share in net assets

Question 2

Preferred Stock Characteristics

Answer 2

1. No pre-emptive rights.
2. No voting power
3. Stocks don’t appreciate in value
4. Dividends are prioritized over common shareholders (dividend in arrears)
5. Tend to receive fixed dividends
6. Preferred over common shareholders in case of liquidation.

Question 3

Stock Valuation Fundamentals

Answer 3

1. Based on expected future cash flows; dividends received and capital appreciation.
2. The market value of a stock is the present value of future cash flows using the investors expected rate of return.

Question 4

Stock Valuation - Discounted Cash Flow Model

Answer 4

P0 = ∑ ( Dn/(1+i)n) + pn/(1+i)n

P0 = Share price today
Dn = Expected dividends per share expected to be paid at end of period
i = Investor's required rate of return (discount rate)
n = Number of periods
pn= Eventual selling price of stock

Question 5

Stock Valuation - Zero Growth Dividend Discount Model

Answer 5

Assumes no growth rate of dividends

P0 = D / r

D = Dividend per share
r = Required rate of return

Question 6

Stock Valuation - Constant Growth Dividend Discount Model

Answer 6

Assumes growth rate is constant and can’t be equal or higher than required rate of return.

Gordon Growth Model
P0 = D1 / r-g

D = Dividend per share
r = Required rate of return
g = Expected dividend growth rate

Question 7

Price to Sales Ratio

Answer 7

Measures company’s sales revenue to it’s stock price

= Total Market Capitalization / Total Sales
= Market Price per Share / Sales per Share

>1 = Overvalued stock price
<1 = Undervalued stock price