chapter 7
the firm has to pay a dividend of 1.20 per share till perpetuity, a zero growth rate of dividends, and a required return of 10%. the value of the firm's preferred stock is?
12
assume all variable stay the same, what effect would each of the following have on stock price? the firms risk premium increases, the firms required return decreases, the dividend expected decreases, the growth rate of dividends is expected to increase.
As the risk premium increases, required return increases and stock price falls. b. As the risk-free rate declines, the required return would also decline. Substituting ks into as rs declines, P0 increases. c. As D1 decreases, the P0 also decreases since the numerator in the dividend valuation models will decline. d. As g increases, the P0 also increases. In the Gordon growth model the value of (r g) in the denominator will become smaller resulting in a higher value.
what are the four ways venture capitalist are organized? how are their dealing structured and priced?
There are four ways in which institutional venture capitalists are most commonly organized. Small business investment companies (SBICs) are corporations chartered by the federal government. Financial VC funds are subsidiaries of financial institutions, particularly banks. Corporate VC funds are firms, sometimes subsidiaries, established by nonfinancial firms. VC limited partnerships are limited partnerships organized by professional VC firms, who serve as general partner. VC investments are made under a legal contract that clearly allocates responsibilities and ownership interest between existing owners and the VC fund or limited partnership. The specific financial terms will depend on factors such as the business structure, stage of development, and outlook. Although each VC investment is unique, the transaction will be structured to provide the VC with a high rate of return that is consistent with the typically high risk of such transactions.
the current price of DEF stock is 26.50 per share. earnings next year should be $2.00 per share and it should pay $1 dividend. the p/e multiple is 15 times on average. what price would you expect of DEF's stock in the future?
30.00
explain the relationship between authorized shares, outstanding shares, treasury shares, and issued shares.
Authorized shares are stated in the company's corporate charter that specifies the maximum number of shares the firm can sell without receiving approval from the shareholders. When authorized shares are sold to the public and are in the hands of the public, they are called outstanding shares. When a firm purchases back its own shares from the public, they are classified as treasury stock. Treasury stock is not considered outstanding since it is not in the hands of the public. Issued shares are the shares of common stock that have been put into circulation. Issued shares include both outstanding shares and treasury stock.
explain each of the three appoarches to common stock valuation: book value, liquidation value, and price earnings multiples? which is considered the best?
Book value is the value of the stock in the event all assets are liquidated for their book value and the proceeds remaining after paying all liabilities are divided among the common stockholders. b. Liquidation value is the actual amount each common stockholder would expect to receive if the firm's assets are sold, creditors and preferred stockholders are paid, and any remaining money is divided among the common stockholders. c. Price earnings multiples are another way to estimate common stock value. The share value is estimated by multiplying expected earnings per share by the average price/earnings ratio for the industry. Both the book value and liquidation value approaches ignore the earning power of a firm's assets and lack a relationship to the firm's value in the marketplace. The price/earnings multiples approach is considered the best approach to valuation since it considers expected earnings. The price-earnings (P/E) ratio also has the strongest theoretical roots. One divided by the P/E ratio can be viewed as the rate at which investors discount the firm's earnings. If the projected earnings per share is assumed to be earned indefinitely, the P/E multiple approach can be looked on as a method of finding the PV of a perpetuity of projected earnings per share (EPS) at a rate equal to the P/E ratio.
what risks to common stock holders take that other suppliers of capital do not?
Common stockholders are the true owners of the firm, since they invest in the firm only upon the expectation of future returns. They are not guaranteed any return, but merely get what is left over after all the other claims have been satisfied. Since the common stockholders receive only what is left over after all other claims are satisfied, they are placed in a quite uncertain or risky position with respect to returns on invested capital. As a result of this risky position, they expect to be compensated in terms of both dividends and capital gains of sufficient quantity to justify the risk they take.
explain the cumulative feature of preferred stock? what is the purpose of the call feature in preferred stock?
Cumulative preferred stock gives the holder the right to receive any dividends in arrears prior to the payment of dividends to common stockholders. The call feature in a preferred stock issue allows the issuer to retire outstanding preferred stock within a certain period of time at a prespecified price. This feature is not usually exercisable until a few years after issuance. The call normally takes place at a price above the initial issuance price and may decrease according to a predefined schedule. The call feature allows the issuer to escape the fixed payment commitment of the preferred stock that would remain on the books indefinitely. The call feature is also needed in order to force conversion of convertible preferred stock.
differences between bonds and stocks
Debt: no voice of manager, tax deductibility, claim income and assets before equity, maturity is states. Equity: voice of manager (vote), tax not deductible, claim on income is subordinate, no maturity.
what are the advantages of both US- based and foreign corporations on issuing shares outside their home markets? what is the American Depository receipts? and American depository shares?
Issuing stock outside of their home markets can benefit corporations by broadening the investor base and also allowing them to become better integrated into the local business scene. A local stock listing both increases local press coverage and serves as effective corporate advertising. Locally traded stock can also be used to make corporate acquisitions. American depository receipts (ADRs) represent ownership of shares of a foreign company's stock held on deposit by the U.S. bank in the companies' home country. ADRs are issued in dollars by an American bank to U.S. investors and are subject to U.S. securities laws, yet still give investors the opportunity to internationally diversify their portfolios. American depository shares (ADSs) are the actual securities that are traded in U.S. markets that represent foreign companies. ADRs are backed up by ADSs.
How does a right offering protect a firm's stockholders against dilution of ownership?
Rights offerings protect against dilution of ownership by allowing existing stockholders to purchase additional shares of any new stock issues. Without this protection current shareholders may have their voting power reduced. Rights are financial instruments issued to current stockholders that permit these stockholders to purchase additional shares at a price below the market price, in direct proportion to their number of owned shares.
what claims do preferred stock have in terms of distribution of earning (dividends) and assets?
The claims of preferred stockholders are senior to those of the common stockholders with respect to the distribution of both earnings and assets.
what general features must a private firm follow to go public in IPO
The general steps that a private firm must go through to go public via an IPO are listed below. The firm must obtain the approval of its current shareholders. The company's auditors and lawyers must certify that all documents for the company are legitimate. The firm then finds an investment bank willing to underwrite the offering. A registration statement must then be filed with the securities exchange commission (SEC). Once the registration statement is approved by the SEC the investment public can begin analyzing the company's prospects.
what is flow
all require estimate of future cash
tax treatment
interest is deductible and dividends are not
PEG
most common RE/ growth
advantage: selling stock and disadvantages
note: companies rarely sell stock to raise money no fixed charges, no maturity date, least amount of constraints, no legal obligation equity cash in disadvantages: disultion of the ownership, control, EPS drop stock price, SEC requires a lot of paperwork, regulations, and disclosure
dividends on common stock
payment of dividends are up to the discretion of the board of directors. Usually quarterly. can be paid as cash, merchandise, or stock. common stockholders are not promised a dividend, but expect payments on the firm's history. first dividends are paid to preferred stock holders.
preferred stock (equity)
preference over common for dividends and claims (paid first) safer, hybrid doesn't mature, no voting like bonds: dividend fixed, call feature, same convertible
zero growth
preferred pmt/ interest is stock price not realistic
a group formed by an investment banker to share the financial risk associated with underwriting new securities is called
underwriting syndicate
how similar to bonds (preferred)
very similar company:infester tax decidable why sell: too much debt- sell preferred no common dilution
probity statement
vote for board of directors, vote of management
julian is considering purchasing the stock of Pepsi cola because he really loves the taste of pepsi. what should julian be willing to pay for pepsi today if it is expected to pay 2 dividend in one year and he expects dividend to grow at 5 percent indefinitely? julian requires a 12 percent return to make this investment
28.57
you are planning to purchase the stock of Ted's shred inc. and you expect it to pay a dividend of 3 in 1 year, 4.25 in 2 years, and 6.00 in year 3. you expect to sell the stock for 100 in 3 years. if you require return for purchasing the stock is 12 percent, how much would you pay for the stock today?
81.52
stock higher profit
= higher return
value of stock is multiple
R/e x EPS= stock price r/e historical doing well higher R/e
dividends are earning approach
R/e= stock $/ EPS= multiple re x eps= stock price
what role does an investment banker have in IPOs? describe the underwriting synthesis.
The investment banker's (IB) main activity is to underwrite the issue. In addition to underwriting theIB provides the issuer with advice about pricing and other important aspects of the issue. The IB may organize an underwriting syndicate to help underwrite the issue and thus to share part of the risk. The IB and the syndicate will put together a selling group who share the responsibility of selling a portion of the issue.
describe, compare, contrast the common stock dividend valuation: zero growth, constant growth, variable growth
The zero growth model of common stock valuation assumes a constant, non growing dividend stream. The stock is valued as a perpetuity and discounted at a rate rs: b. The constant growth model of common stock valuation, also called the Gordon model, assumes that dividends will grow at a constant rate, g. The stock is valued as the PV of the constantly growing cash flow stream: c. The variable growth model of common stock valuation assumes that dividends grow at a variable rate. The stock with a single shift in the growth rate is valued as the PV of the dividend stream during the initial growth phase plus the PV of the price of stock at the end of the initial growth phase:
dividend valuation model affected by
eps, cash flow, # reflects value
constant growth
eps/ 1-g realistic- flow grow @ constant rate big company manage earning and growth constant rate
fair value
future value PV, EPS growth @ variable + constant
higher discount rate, higher risk, growth rate lower
higher value, lower value, lower value
eps (decrease)
net income/ shares outstanding (increase) common stock outstanding preferred not affected
which of the following is an advantage for a firm to issue common stock over long-term debt?
no maturity date on which the par value of the issue must be repaid.
common stock, public, private
ownership- company is owned by stockholders pubic- 1000 owners private- 1 or a gamily
which of the following is an attribute of investment bankers?
they bear the risk of selling a security issue
explain the linkage among financial decisions, return, risk, and stock valuation
A decision or action by the financial manager can have an effect on the risk and expected return of the stock, both of which are part of the stock valuation model.
what is the difference between venture capitalist and angles capitalist
Venture capitalists (VC) are typically business entities that are organized for the purpose of investing in attractive growth companies. Angel capitalists are generally wealthy individuals who provide private financing to new businesses. Firms usually obtain angel financing first, then as their funding needs get too large for individual investors they seek funds from venture capitalists.
dividends
board of directors determine quantity not all stock pays dividends receive after everything is satisfied most people don't buy primarily for dividends
calc dividend yield
dividends paid/ stock price
___ is the actual amount each common stockholder would expect to receive if a firm's assets are sold for their market value, creditors and preferred stockholders are repaid, and any remaining money is divided among the common stockholders
liquidation value
spilt stock
muilple shares (not common) why spilt? less demand for stock not going to buy @ higher price look at EPS not stock price. look at growth spilt brings down the price to trading range good news- stock price does better after spilt
in the gordon model, the value of a common stock is the
present value of a constant growing dividend stream
variable growth
reflects actual business we don't know % growth we had to guess to pt and then use constant
if expected return is less than required return on an asset, rational investors will_
sell the asset, which will drive the price down and cause the expected return to reach the level of required return
describe the events that occur in an efficent market in response to new information that causes the expected returns to exceed the required returns. what happens to the market value.
the efficient market hypothesis says that in an efficient market, investors would buy an asset if the expected return exceeds the current return, thereby increasing its price (market value) and decreasing the expected return, until expected and required returns are equal.
