Finance Chapter 7: Stock and Stock Valuation (Equity)

The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations? I. firms that have a 100 percent retention ratio II. firms that pay a constant dividend III. firms that pay an increasing dividend IV. firms that pay a decreasing dividend A. I and II only B. I and III only C. II and III only D. I, II, and III only E. II, III and IV only

E. II, III and IV only

Know the various types and features of preferred stock

Hybrid security •Has similarities to bonds (debt) and common stock (equity) •Par Value (i.e. liquidation value) •If firm is liquidated this is price preferred shareholders must be paid- i.e. the face value of the stock •Dividend •The dividend is stated as a percentage of par value •Cumulative dividend •Maturity •No specific maturity date •Sometimes have call provisions

100% retention rate

No dividend

What is the dividend discount model

The dividend discount model (DDM) is a method of valuing a company's stock price based on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their present value. In other words, it is used to value stocks based on the net present value of the future dividends. price in year t = div of following year P=D1/r-g

Six months ago, you purchased 100 shares of stock in Global Trading at a price of $38.70 a share. The stock pays a quarterly dividend of $0.15 a share. Today, you sold all of your shares for $40.10 per share. What is the total amount of your dividend income on this investment? • A. $15 • B. $30 • C. $45 • D. 50 • E. $60

B. $30

Last year, you purchased 500 shares of Analog Devices, Inc. stock for $11.16 a share. You have received a total of $120 in dividends and $7,190 from selling the shares. What is your capital gains yield on this stock? • A. 26.70 percent • B. 26.73 percent • C. 28.85 percent • D. 29.13 percent • E. 31.02 percent

C. 28.85 percent

Coca-Cola Co (KO) on June 18, 2014 traded at $41.56 per share with an EPS (TTM) of $1.87 Calculate P/E ratio

Calculate P/E ratio =Stock price/ EPS To determine the P/E ratio, investors can divide the stock price by EPS. For example, , so the P/E ratio would be: Stock price ($41.56) / earnings per share ($1.87) = 22.22.

Know the various types and features of common stock

Common stock: Par Value •Often does not exist •Legally, it represents a stockholders minimum financial obligation in the even the corporation is liquidated and debts are paid •Comes out of payment for initial shares •NOT RELATED TO MARKET VALUE OF SHARES Dividends •Firm has no obligation to pay dividends to common stockholders •Income vs Growth stocks •Maturity •No specific maturity date •May be repurchased •Firm has a lot of excess cash and no investment opportunities •Price of stock is undervalued (aka cheap) •Management wants to gain more ownership control (hold a greater % of shares) •Priority to Assets and Earnings •Receive any distributions LAST •Control of the firm •Elect firms Board of Directors, vote on proposals (mergers, changes in charters, etc.) •Generally one share = one vote •Proxy

Sweet Treats common stock is currently priced at $18.53 a share. The company just paid $1.25 per share as its annual dividend. The dividends have been increasing by 2.5 percent annually and are expected to continue doing the same. What is this firm's cost of equity? •A. 6.03 percent •B. 6.18 percent •C. 8.47 percent •D. 9.41 percent •E. 9.82 percent

D. 9.41 percent div yield + g D0*(1+g)=D1

An increase in which of the following will increase the current value of a stock according to the dividend growth model? I. dividend amount II. number of future dividends, provided the current number is less than infinite III. discount rate IV. dividend growth rate • A. I and II only • B. III and IV only • C. I, II, and III only • D. I, II, and IV only • E. I, II, III and IV

D. I, II, and IV only

Stacy purchased a stock last year and sold it today for $3 a share more than her purchase price. She received a total of $0.75 in dividends. Which one of the following statements is correct in relation to this investment? • A. The dividend yield is expressed as a percentage of the selling price • B. The capital gain would have been less had Stacy not received the dividends • C. The total dollar return per share is $3 • D. The capital gains yield is positive • E. The dividend yield is greater than the capital gains yield

D. The capital gains yield is positive

Understand the return components of a stock and how to calculate them • Dividend Yield • Capital Gains

• Dividend Yield • Capital Gains: g or (new-old)/old

Understand the various dividend discount models (DDM). Be able to compute the price of stock based on the models below or dividends • Zero-growth = perpetuity, preferred stock • Constant-growth • Non-Constant growth

• Zero-growth = perpetuity, preferred stock • Constant-growth: The most recent dividend paid (D0) by Platypus Ltd. was $1.50; the firm is expected to grow at a constant rate (g) equal to 5 percent; and the required rate of return (re) on similar risk investments is 15 percent. • Non-Constant growth: calc pv for divs and constant growth portion*pay attention to d0 and d1 •Step 1 -- Prior to the point where constant growth begins: •Compute the dividend for each year •Find the present value of each dividend and sum them •Step 2 -The year constant growth beings •Apply the constant growth model to compute the value of the expected dividends from that point forward. •Compute the present value of the stock's value at the point where you assume constant growth begins. •Finally sum the PV results from step 1 and 2