Topic 3 - Stock Prices

Question 1

Dividend Discount Model

Answer 1

A method of valuing a company’s stock price, based on the idea that a company is worth the sum of all future dividend payments, discounted back to present value.

Question 2

Equity Cost of Capital ‘Re’

Answer 2

A percentage rate that represents the annual rate of return that investors can expect on their investment in a company.

Question 3

Capital Gain Rate

Answer 3

The percentage increase in a stocks price from when it was bought to when it was sold. Showing the profit made from the stocks price increase alone.

Question 4

A stock

Answer 4

a share of ownership in a company

Question 5

Limitations of DDM

Answer 5

• Very sensitive to change
• Management Discretion
• Dependence of Dividends - not all company’s pay regular dividends
• Assumption of Constant growth

Question 6

Free Cash Flow Valuation model

Answer 6

This model values a firms stock price based on the cash it generates after covering all its costs. I.e. the cash it has to put towards dividends or reinvesting in the company

Question 7

WACC

Answer 7

weighted avg cost of capital - the avg rate of return that a company must pay its investors fro using their money. it represents the minimum return the company must earn on its investments to satisfy investors.

Question 8

Comparable Method

Answer 8

A valuation method that uses the value of another very similar firm to create an estimate of a new firms value.

Question 9

Limitations of Comparable Method

Answer 9

• hard to find similar company
• cannot determine if the entire industry is overvalued or undervalued
• other outlying factors need to be considered