ch. 7 stock valuation
calculation for expected return
E(r) = D/ (P + g)
dividend of a preferred stock
dividend expressed as either a $ amount or a % of its par values; thus par value has significance
what are cash flows of a stock
dividends, residual claim on a firm's assets when the company dissolves
common stock voting rights
each share entitles its holder to one vote in the election of directors and on special issues; generally assignable and may be cast at annual meeting
market value
equal to the actual value; based on expected discounted cash flows looking at all them theoretically and discounting appropriately to the present value
permanent financing
equity capital (unlike debt) has no maturity date and never has to be repaid by the firm
highest cost for underwriting
equity is highest, followed by preferred stock, and then bonds
preferred stock
equity that usually pays a fixed dividend and has a prior claim on the firm's earnings and assets case of liquidation; a type of hybrid security
compensation for stockholders
expect period dividends and capital gains for their investment in a firm's shares
role of investment bankers
financial intermediaries that specialize in selling new securities and advising firms with regard to major financial transactions; assists with most public offerings that are made
rights offering to the primary market
firm sells new shares to existing shareholders
bonds
fixed income securities where dividends never change; similar to preferred stocks
classes of voting rights
for common stock many firms issue two or more classes differing in having unequal voting rights; usually class A common stock is designated as nonvoting while class B is designated as voting
par value of common stock
generally low ($1) and is a relatively useless value established in the firm's corporate charter; can be advantageous in states where certain corporate taxes are based on the par value of stock
benefits of a road show
helps investment bankers gauge the demand for the offering which helps them to set the initial offer price, which must be approved by the SEC after the underwriter sets the terms
equity capital
holders are owners of the firm; have the privilege to elect the firm's board of directors and to vote on special issues
how firms raise capital from the sale of stock
in the primary market
what kind of deduction does debt have?
interest deduction
road show
investment bankers and company officials promote the company by making a series of presentations to potential investors throughout the country and even globally
undervalued stock
investors purchase
overvalued stock
investors want to sell
underwriting
involves the purchase of the security issue from the issuing company at an agreed-on price and bearing the risk of selling it on the public at a profit; main activity of an investment banker
problems from lessening agency costs
managerial risk aversion, managerial bias in accounting
managerial risk aversion
managers unable to diversify their firm specific human capital investments may engage in less risky business decisions than what would be preferred by equity holders
investment banker
responsible for promoting the stock and selling its shares
common stock
riskiest position (therefore highest expected return) equity that may pay no dividend or a discretionary dividend; receives a residual claim on the firm's earnings and assets as well as voting rights (meant to represent the board of directors)
residual claim priority
stockholders are the last in line of all those who have a claim on the assets and income of the corporation; preferred stockholders have priority over common
interest paid to bondholders
tax deductible to the issuing firm
how a stock is valued
the NPV of all future cash flows (like any asset)
public offering (IPO)
when a firm offers its shares for sale to the general public (our focus) when a firm wishes to sell its stock in the primary market
proxy battle
when the firm is widely owned, outsiders may attempt to unseat existing management and gain control
secondary market
where shares of stock already in the public's hands are traded and the firm receives no money from secondary market sales of sock
private equity investors
where the initial non-founder financing usually first comes from; early debt or equity investors are only likely to make an investment if the founders also have a personal stake in the business
dividends are constant
zero growth => calculating the value of a perpetuity; also the appropriate valuation technique for valuing preferred stock
constant growth model
P = D/ (r-g)
zero growth model
P= D * (1/r)
red herring
a preliminary prospectus that prospective investors can review while the firm waits for SEC approval
proxy statement
a signed statement from the shareholders giving their votes to another party because most do not attend the annual meeting to vote
par value
a value assigned to a share of stock and printed on the stock certificate; has real significance for a preferred stock
going public
after establishing itself, a firm will begin issuing shares of stock to the primary market, a much broader group where it has 3 alternatives
quiet period
after the IPO is complete, the company must observe an amount of time that restricts company statements
preemptive right
allows common stockholders to maintain their proportionate ownership in a corporation when new shares are issued
debt
an amount owed to a person or organization for funds borrowed
preferred stock payment
an equity instrument that usually pays a fixed dividend and has a prior claim on the firm's earnings and assets in case of liquidation'
dividends
are NOT tax deductible; tax size is influencing firms to be riskier and take on more debt; business's deal with tax deduction
book values
based on accounting data to supply data in finance
common stockholders expected compensation
because of their uncertain position, residual claimants expect to be compensated with adequate dividends and ultimately capital gains
who does not get voting rights?
bondholders and preferred stockholders
percentage terms of costs
can be as high as 17% for small stock offerings, as low as 1.6% for large bond issues
residual claim
can not be paid until the claims of all creditors, both interest and principle payments on debt, have been satisfied
method to lessen agency cost
compensate managers with stock and or stock options; thus, the managers' interests become more closely aligned to those of other owners
dividends change
constant growth rate assumes that the stock will pay dividends that grow at a constant rate each year to infinity
underwriting syndicate function
creates a selling group, of investment bankers, which distributes the shares to the investing public
dividend payments
may be made in cash, additional shares of stock, and even merchandise; b/c they are residual claimants, they are compensated only after all claims have been settled with the government, creditors, and preferred stockholders
what kind of deduction does preferred and common stock have?
no deduction
agency problems
occur when a manager acts in his or her own best-interests rather than in the interests of the owners
equity
ownership interest in a corporation in the form of common stock or preferred stock; also refers to total assets minus total liabilities
prospectus
part of the registration statement which describes the key aspects of the issue, the issuer, and its management and financial position
common stock payment
payment of dividends is at the discretion of the board of directors
cumulative preferred stock
pays a fixed dividend, receives first priority in dividend payment, and maintains the right to a dividend payment, even if that payment is deferred
characteristics of common stock
perpetual securities with no maturity date makes, similar to preferred stock
voting control
preemptive rights allow existing shareholders to exercise and maintain voting control and protect against the dilution of their ownership
cumulative preferred stocks
preferred stocks that must pay preferred dividends and any arrearage before common stockholders may receive a dividend
capital gains
profits generated when selling shares of stock in the secondary market (NYSE, NASDAQ)
managerial bias in accounting
public disclosure of information
hybrid securities
reference to preferred stock because they possess the characteristics of both common stocks and bonds
spread
the difference between the price paid for the securities by the investment banker and the eventual selling price in the market place
failure to pay a preferred stock dividend
the dividend is said to be in arrears
rights offering
the firm grants rights to its existing shareholders, which permits them to purchase additional shares at a price below the current price
private placement
the firm sells new securities directly to an investor or a group of investors
primary market
the first time a given set of stock is sold to investors where the proceeds go to the corporation (less the 'spread' earned by investment bankers)
treasury stock
the number of outstanding shares that have been purchased by the firm
outstanding shares
the number of shares of common stock held by the public
authorized shares
the number of shares of common stock that a firm's corporate charter allows
issued shares
the number of shares that have been put into circulation including both outstanding shares and treasury stock
stock
the ownership shares in a publicly-held company
residual claimants
the true owners of the firm; used to refer to common stockholders; receive what is left after all other claims on the firms income and assets have been satisfied
registration statement
to go public, a company must submit this file with the SEC which includes a prospectus
small corporations and common stock
typically are privately or closely owned by an individual or small group of investors and occurs infrequently and in small amounts if shares are traded
how investment bankers earn return
typically by profiting on the spread
initial issuance of common stock
typically comes from a firm's original founders in the form of common stock investment
underwriting syndicates
typically form when companies bring large issues to the market; each investment banker underwrites a portion of the issue in order to reduce the risk of loss for any single firm and insure wider distribution of shares
typical use for IPOs
typically made by small, fast-growing companies that either (1) require additional capital to continue expanding or (2) have met a milestone for going public that was established in a contract to obtain VC funding
company tendency to dissolve
typically only unless forced by bankruptcy where the residual claim is $0
large corporations and common stock
typically publicly owned by a broad group of investors and have shares that are actively traded on major securities exchanges
underwrite
when a firm hires an investment bank to obtain approval of current shareholder offerings