Term
| the value of an asset depends on |
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Definition
the magnitude of the cash flows
timing of cf
risk of cf |
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Term
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Definition
unlike bonds, equities do not have well defined, finite lives
equity securities have the feature that cash flows are uncertain
because of the increased uncertainty, risk plays a greater role |
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Term
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Definition
are residual claimants to the assets of the firm
have limited liability
have voting rights
are eligible for dividends if and when dividends are declared (stockholders) |
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Term
| holders of Preferred Stock |
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Definition
do not have voting rights
have preference over common stock in receiving dividends (a fixed amount)
have right to dividend arrearages
have stated liquidation value
(preferred stock is like a perpetual bond)
The preferred stockholder's claims are junior to the bondholder's claims but senior to the common stockholders' claims. |
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Term
| Between bonds, common stock, and preferred stock, which is the riskiest? |
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Definition
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Term
| Which has the lowest expected return? (bonds, common stock or preferred stock) |
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Definition
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Term
| The value of an asset is determined by the present value of its future cash flows. What are the cash flows for a stock? |
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Definition
1. dividends
2. proceeds from sale of stock |
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Term
| Present value of the stock (P0) |
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Definition
P0=D1/(1+r) + D2/(1+r)^2 + D3/(1+r)^3 ........
sell the stock at the end of the year for P1 and receive a dividend of D1 |
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Term
| No matter what our time frame for holding the stock, we can calculate the value of a stock as the |
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Definition
| present value of all future dividends |
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Term
| Two serious problems when the present value of stock equation is applied to try to create stock value |
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Definition
don't know what the future dividends will be (so assume certain dividend patterns)
don't know the discount rate to use in the calculation |
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Term
| Zero Growth in Dividends (special case in stock valuation) |
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Definition
treat it as a perpetuity (stock price increase at price of dividend)
P0=D1/r
based on getting the first dividend payment in one year
if the first dividend payment were today,
P0=D0 + D1/r = D + D/r |
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Term
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Definition
for a growing perpetuity
P0 (price today) = D0 (1+g)/(r-g) = D1/(r-g)
this only works if r is greater than g
assumes 1st payment is received in period 1
known as the "DIVIDEND GROWTH MODEL" |
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Term
| To find the price in x years |
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Definition
| 1. find the D value of Dx+1 2. plug it into Px equation--> Dx+1/(r-g) |
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Term
| Non-constant Dividend Growth |
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Definition
this is used for younger companies where dividends will take time to settle into a reasonable pattern of growth (assume the transition period will end and there will eventually be constant growth)
collapse cash flows to a finite cash flow and then find the period
P0 = Px/(1+r)^x |
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Term
| As long as the firm eventually pays dividends in the future, |
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Definition
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Term
| Why would a firm not pay dividends? |
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Definition
if it is growing really fast and they are reinvesting back into the company
if you earn more than the shareholders, invest rather than pay dividends |
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Term
| Components of Required Return |
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Definition
| dividend yield + capital gains yield (how fast stock is depreciating) |
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Term
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Definition
| the riskiness of cash flows affects the value of an asset. the discount rate is what makes the adjustment. |
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Term
| riskier cash flows require |
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Definition
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Term
| risky cash flows are worth less than |
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Definition
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Term
| Where do we get the discount rate? |
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Definition
CAPM
Historical rate or Peer Group rate |
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Term
| Problems with Stock Valuation |
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Definition
answer to any present value analysis is highly sensive to the DR
determination of the DR is far from perfect
with stocks, the cash flows themselves are often difficult to accurately forecast
(understand errors--sensitivity analysis) |
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Term
| discount rate goes up, value of the stock |
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Definition
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Term
| if the stock market undervalues the stock, if it overvalues |
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Definition
| undervalue - buy over value - sell |
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