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