Chapter 8 FINANCE

Priority

Shares of Stock are a lower priority claim than bonds, and are sometimes called residual claims

What is Stock

A share of common stock, or equity, represents an ownership claim on a firm that has no maturity and no promised payments Payments are in the form of dividend that are declared at the discretion of the board of directors

Stockholder

part owner so you share the profits, no limit on how much money you can make but you also may not make any money Have to predict what money you will get back in dividends

Common Stock Valuation

A share of common stock is more difficult to value in practice than a bond because for common stock promised cash flows are not known in advance. Common stock is forever because it has no maturity. It isn't easy to observe the rate of return that the market requires

Zero-Growth Model

A share of preferred stock has no maturity, but receives a pre-specified regular dividend. (A share of preferred stock is like a perpetual bond) pays a fixed dividend Po=D/r (starts 1 period later ex at year 1 not year 0) Po= Present Value of a preferred stock D=Dividen r=required rest of return on the stock

Constant Growth Rate

Po=D1/r-g

Preferred Stock

Preferred stock comes after bonds in paying out dividends and then common stock Preferred stock holders get a fixed payment (basically perpetuity) Stock holders typically carry voting rights to elect directors and approve certain actions

Non-Constant Growth

Used when dividend are expected to grow at a constant rate for a fixed period of time and then the growth rate changes

Dividen Yield

rdiv= dividend per share/price of stock = D1/Po

Capital Gain yield

reg= (ending price- beginning price)/beginning price = (P1-P0)/P0

Required Rate of Return

rdiv+reg