Corporate Fin: Chpt. 9

  1. Characteristics of Common Stock
    Certificate represents ownership interest in the firm

    No par value or coupon interest rate

    No maturity date; exists as long as the firm does

    • Dividends must be declared by Board of Directors
    • No legal rights to receive dividends
    • Not deductible for income tax purposes

    Capital gains on the sale of stocks

    Claim on assets comes after creditors, bondholders, and preferred stockholders

    Voting rights for Board of Directors and corporate charter can be exercised in person or by proxy

    Preemptive right entitles shareholders to maintain their proportionate share of ownership.
  2. Preemptive right
    entitles shareholders to maintain their proportionate share of ownership.
  3. The Stock Markets:
    Primary vs. Secondary

    Organized security exchanges
  4. Organized security exchanges
    License holders (formerly "Member")

    Entitled to buy or sell on the exchange floor

    Brokers vs. Dealers
  5. Brokers vs. Dealers
    Commission brokers

    • Specialists
    • Bid price, Ask price, Spread
  6. Over-the-Counter Market
    NOT a physical exchange

    Telecommunication, computer-based network

    National Association of Security Dealers Automated Quotations (NASDAQ)

    Electronic Communications Networks (ECNs)
  7. The value of any asset is the ____________ of its expected future cash flows
    present value
  8. Stock ownership produces cash flows from:

    Capital gains
  9. Valuation of different types of Stocks
    Zero Growth

    Constant Growth

    Differential Growth
  10. Zero Growth definition
    Dividends will remain at the same level forever
  11. Zero Growth model
    Div1 = Div2 = Div3 = ...
  12. Zero Growth value
    Since future cash flows are constant, the value of a zero growth stock is the present value of a perpetuity

    P0 = Div1/(1+R)^1 + Div2/(1+R)^2 + Div3/(1+R)^3 + ...


    P0 = Div/R
  13. Constant Growth definition
    Assume that dividends wil grow at a constant rate, g, forever.
  14. Constant Growth model
    Div1 = Div0(1+g)

    Div2 = Div1(1+g) = Div0(1+g)^2

    Div3 = Div2(1+g) = Div0(1+g)^3
  15. Since the future cash flows grow at a constant rate forever, the value of a constant growth stock is the: (definition + formula)
    present value of a GROWING PERPETUITY:

    P0 = Div1/R-g
  16. Differential Growth definition
    Assume that dividends will grow at DIFFERENT foreseeable future and then will grow at a CONSTANT rate thereafter
  17. The value of a firm depends upon its ________ and its ________.
    growth rate; discount rate
  18. Retention ration formula
    Retained Earnings/Earnings
  19. Return on Equity:
    Earnings/Stockholders' Equity
  20. Where does g come from?

    g =
    g = Retention ratio * Return on Equity
  21. Where does R come from?

    The discount rate can be broken into two parts:
    The dividend yield.

    The growth rate (in dividends)
  22. Dividend yield:
    = D/invest price
  23. Growth Opportunities

    Cash Cow definition
    company that pays out all of its earnings as dividends
  24. Growth opportunities are
    opportunities to invest in positive NPV projects
  25. The value, or stock price, of a firm represents:
    value of a firm that pays out 100% of its earnings as dividends plus.

    net present value of the growth opportunities
  26. Value, or stock price formula
    P = EPS/R + NPVGO
  27. An increase in the retention rate will:
    REDUCE the DIVIDEND paid to shareholders

    INCREASE the firm's GROWTH rate
  28. Retention rate and Firm value have ________ influences on ______ price.
    offsetting; stock
  29. Which one dominates? Retention rate or Firm Value? explain.
    If ROE > R, then increased retention INCREASES firm value since reinvested capital earns more than the cost of capital
  30. Price-Earnings Ratio formula
    P/E ratio = Price per share/EPS
  31. Price-Earnings ratio definition
    The price-earnings ratio is calculated as the current stock price divided by annual EPS
  32. The Wall Street Journal uses last __ quarter's earnings
  33. PE ratio is related to the _______ of growth opportunities of the firm.

    PE ratio is related to the ______ of the firm.
    NPV; risk
Card Set
Corporate Fin: Chpt. 9
Exam 2: part 1