Principles of Finance- Chapter 7

cash flows

Po = (D1 + P1) / (1 + R)

Zero Growth

Po = D/R

What is the formula for the present value of a growing perpetuity where C1 is the net cash flow, R is the required return and g is the growth rate?

P = C1/(R-g)

Which of the following ratios might be used to estimate the value of a stock?

The Price/Sales ratio The Price/Earnings ratio

a person who brings buyers and sellers together is called

broker

If unpaid preferred dividends must be "caught up" before any common dividends can be paid, they are called _________ dividends.

cumulative

Someone who maintains and inventory of stocks and buys and sells those stocks is known as a ______

dealer

All else constant, the dividend yield will increase if the stock price ____. Multiple choice question.

decreases

In the dividend growth model, the expected return for investors comes from which two sources?

dividend yield growth rate

The price of a share of common stock is equal to the present value of all ______ future dividends.

expected

True or false: Daily stock prices can only be found by looking up the stock in newspapers.

false

When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as follows:

one vote per share held

The fundamental business of the New York stock Exchange is to attract _______

order flow

Preferred stock has preference over common stock in the:

payment of dividends distribution of corporate assets

Shares o stock are first brought to the market and sold to investors in the ______ market

primary

New York Stock Exchange Designated Market Makers (DMMs) were formerly called ________ .

specialists

A benchmark PE ratio can be determined using:

the PEs of similar companies a company's own historical PEs

The dividend yield is determined by dividing the expected dividend (D1) by:

the current price (P0)

The dividend yield is determined by dividing the expected dividend (D1) by:

the growth (g)

A share of common stock is more difficult to value in practice than a bond, for these three reasons

1. With common stock, not even the promised cash flows are known in advance 2. The life of the investment is essentially forever because common stock has no maturity 3. There is no way to easily observe the rate of return that the market requires

Which of the following are cash flows to investors in stocks?

Dividends capital gains

The value of a firm is derived using the firm's ______ rate and its _______ rate.

Growth; discount

The two most important stock markets in the U.S. are the New York Stock Exchange and ______.

NASDAQ

Which of the following are rights of common stock holders?

The right to share proportionally in any residual value in the event of liquidation. The right to vote on matters of importance. The right to share proportionally in any common dividends paid.

Zero Growth Example- Suppose the Paradise company has a policy of paying a $10 per-share dividend every year. If this policy is to be continued indefinitely, what is the value of a share of stock if the retired return is 20%?

The stock in this case amounts to an ordinary perpetuity, so the stock is worth $10/.20 = $50 per share

dividend growth model

A model that determines the current price of a stock as its dividend next period divided by the discount rate minus the dividend growth rate Can use the dividend growth model to get the stock price at any point in time, not just today

Imagine you are considering buying a share of stock today. You plan to sell the stock in one year. You somehow know that the stock will be worth $70 at the time. You predict that the stock also will pay a $10 per share dividend at the end of the year. If you require a 25 percent return on your investment, what is the most you would pay for the stock? In other words, what is the present value of the $10 dividend along with the $70 ending value at 25 percent?

If you buy the stock today and sell it at the end of the year, you will have a total of $80 in cash. At 25 percent: PV= ($10 + 70)/1.25 = $64

Dividend Growth- The Hedless Corporation has just paid a dividend of $3 per share. The dividend of this company grows at a steady rate of 8 percent per year. Based on this information, what will the dividend be in five years?

Here we have a $3 current amount that grows at 8 percent per year for five years. The future amount is thus: $3 x 1.08^5 =$3 x 1.4693 = $4.41 The dividend, therefore, will increase by $4.41 - 3= $1.41