Chapter 8 - Stock Valuation

According to the average accounting return rule, a project is acceptable if its average account return exceeds ______.

A target average accounting return

The assumption of constant growth infers that _______.

Dividends change at a constant rate

What is a specialist?

The NYSE member who acts as a dealer in a small number of securities.

What is the constant growth rate?

The dividend always grows at a steady rate. *INSERT FORMULA*

When the stock being valued does not pay dividends = ?

The dividend growth model can still be used. The analyst must assume at some point in the company's future, it beings paying dividends

When the stock being valued does not pay dividends, --> ?

The dividend growth model can still be used

What is two-stage growth?

A special case of nonconstant growth. *INSERT FORMULA*

What are the components of the required return?

*INSERT FORMULA*

NASDAQ has which of these features?

1) Computer network of securities dealers 2) Multiple market maker system

What are some shareholder rights?

1) Control the corp through the right to elect directors (only shareholders have this right) More basics: directors are elected each year at annual meetings --> one share, one vote = shares MUST be voted cumulatively or voted straight

Which of the following are expected cash flows to investors in stocks? (2)

1) Dividends 2) Capital gains

What are some characteristics of dividends?

1) Dividends are not a lability of a corp 2) The payment of dividends by the corp is not a business expense. They are not deductible for corporate tax purposes. 3) Dividends received by individual shareholders are taxable.

Which of the following are features of common stock?

1) It has no special preference in bankruptcy 2) It has no special preference in receiving dividends 3) It generally has voting rights

What are the two biggest stock markets in the US?

1) NYSE 2) NASDAQ

What is straight voting?

1) The directors are elected one at a time 2) All or nothing 3) No minority shareholder would have enough votes to win any seat on board

Why is a share of common stock more difficult to value than a bond?

1) 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 easy way to observe the rate of return that the market requires

What are the various rights that come with owning a share of common stock in a corporation?

1) The right to vote to elect corporate directors 2) Voting in corporate elections (cumulative or straight) --> most voting is done by proxy. A proxy battle breaks out when competing sides try to gain enough votes to elect their candidates for the board.

Preferred stock has preference over common stock in the __________

1) payment of dividends 2) distribution of corporate assets

A benchmark PE ratio can be determined using:

1) the PEs of similar companies 2) a company's own historical PEs

What are the effects of cumulative voting?

1) to permit minority participation --> If cumulative voting is permitted, the total # of votes that each shareholder may cast is determined first --> This is calculate as # of shares x # of directors to be elected 2) With cumulative voting, the directors are elected all at once.

What is a broker?

A broker brings buyers and sellers together but does not maintain an inventory like a dealer does.

What do we do when companies dont pay dividends?

A common approach is to make use of the PE ratio. *INSERT FORMULA*

What is a dealer?

A dealer maintains an inventory and stands ready to buy and sell at any time (Think of a car dealership. Salesmen have to maintain a car inventory in order to sell deals)

What are dividends?

A distinctive feature of corps is that they have shares of stock on which they are authorized by law to pay dividends to their shareholder. Dividends paid to shareholders represent a return on the capital contributed to the corp by the shareholders.

What is a designated market maker?

An NYSE member who acts as a dealer in particular stocks (if they are particular then they must be designated)

The Average Accounting Return (AAR) is calculated by taking the average net income and dividing it by the average ______ value.

Book

The cash flows from owning a share of stock come in the form of future ______.

Dividends *In special cases it is possible to calculate the PV of all the future dividends and come up with a value for the stock*

(T/F) For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.

False --> neither dividends nor capital gains are fixed are guaranteed

An NYSE member who executes customer buy and sell order is called a ______ broker

Floor broker

Stock price reporting has increasingly moved from traditional print media to the ______ in recent years.

Internet

What is the zero growth rate?

Just as it implies, zero growth and is constant through time. Because the dividend is always the same --> the stock van be viewed as an ordinary perpetuity *INSERT FORMULA*

Which of the following occurs in the primary market?

Newly issued stocks are initially sold

Which of the following entities declares a dividend?

The Board of Directors

When voting for the BOD, the # of votes a shareholder is entitled to is generally determined as follows:

One vote per share held

What is staggering?

Only a fraction of the directorships are up for election at a particular time

The trading of existing shares occurs in the ______ market

Secondary

The goal of many successful organizations is a ______ rate of growth in dividends

Steady

With ______ voting, the directors are elected one at a time and the only way to guarantee a seat is to own 50% plus one share.

Straight

Investment firms that are active participants in stocks assigned to them are called ______ liquidity providers

Supplement (SLP)

What is preferred stock?

The name stems from the fact that preferred stockholders must be paid first, before common stockholders can receive anything. Preferred stock has a fixed dividend. Preferred stock sometimes have no voting privileges

What is the ask price?

The price at which the dealer will sell

What is the bid price?

The price that the dealer is willing to pay

What is non-constant growth?

This case is to allow for "supernormal" growth rates over some finite length of time. *REFER TO TEXTBOOK EXAMPLE*

What is the difference between the bid and ask prices?

This is called the spread and it is the basic source of dealer profits

What is common stock?

Usually applied to stock that has no special preference either in receiving dividends or in bankruptcy

Important note about IRR and NPV

When the internal rate of return is equal to its required then the NPV must be zero

What are the 2 basic effects of staggering?

1) Staggering makes it more difficult for a minority to elect a director because there are fewer directors to be elected at one time 2) Staggering makes takeover attempts less likely to be successful because it makes it more difficult to vote in a majority of new directors. *Staggering may serve a beneficial purpose --> it provides institutional memory - continuity on the BOD. This may be important for corps with long range plans

What (3) assumptions can be made about the pattern of future dividends?

1) The dividend has a zero growth rate 2) The dividend grows at a constant rate 3) The dividend grows at a constant rate after some length of time *Each of these are considered separately

What is a proxy?

A proxy is the grant of authority by a shareholder to someone else to vote his or her shares