Finance Ch. 7

proxy

a grant of authority by a shareholder allowing another individual to vote that shareholder's shares, management tries to get as many proxies as possible;

straight voting

a procedure by which a shareholder may cast all votes for each member of the board of directors

cumulative voting

a procedure in which a shareholder may cast all votes for one member of the board of directors

dividend yield

a stocks expected cash dividend divided by its current price

dealer

an agent who buys and sells security transactions among investors

member

as of 2006, a member is the owner of a trading license on the NYSE.

zero growth rate (dividends)

much like preferred stock, in this case common stock dividends do not grow. for zero growth on common stock, this implies that: D1 = D2 = D3 = D = CONSTANT so, the value of stock is, P0 = D / (1+R)^1 + D/ (1+R)^2 + D / (1+R)^3 ...... thus we can view this as an ordinary perpetuity with a cash flow equal to D every period: **** P0 = D/R ***** where r is the required return ex// dividend of $10/share and we need a return of 20% 10/.20=50.....$50 is the current worth of the stock

Constant Growth

suppose we know that instead, the dividend for a company grows at a steady rate, g. If we let D0 be the dividend just paid, then the next dividend, D1, is: D1 = D0 x (1+g) The dividend in two periods would be: D2 = D0 x (1+g)^2

What are the relevant cash flows for valuing a share of common stock?

the PV of future dividend payments

capital gains yield

the dividend growth rate, or the rate at which the value of the investment grows (g)

primary market

the market in which new securities are originally sold to investors

secondary market

the market in which previously issued securities are traded among investors

What is the value of a share of stock when the dividend grows at a contant rate?

use the dividend growth model: where g is equal to a constant rate P0 = D1 / (R-g)

common stock

equity without priority for dividends or in bankruptcy

Dividend Growth Model

If the dividend grows at a steady rate than we have replaced the problem of forecasting an infinite number of future dividends. P0 = D0 x (1+g) / R - g = D1 / R - g ex// suppose D0 (dividend just paid) is $2.30, the rate of return is 13%, and g (the dividends rate of growth) is 5 %, the price per share would be: P0 = D0 x (1+g) / (R - g) =$2.30 x 1.05 / (.13 - .05) =$30.19 we can use this model to get the price of stock for any period in the future; we just use the constant growth model above and then plug it in: D5 = D0 x (1+g)^5 = $2.30 x 1.05^5 = $2.935 and then plug it in P5 = D5 x (1+g) / (R-g) =2.935 x 1.05 / .13 - .05 =$38.53 in five years

broker

an agent who arranges security transactions among investors

Nonconstant Growth

this is to make up for a fluctuating growth rate over a period of time ex// you predict that in five years the company will pay its first dividend of $.50/share. You expect this dividend to grow 10%/year indefinitely. The required return is 20%, what is the price of stock today? we must first find out what it will be worth once dividends are paid: we can say that the price in 4 years will be: P4 = D4 x (1+g) / R-g) =D5 / (R-g) =.50 / (.20 - .10) =$5 if the stock is worth $5 in four years then we can get the current value by discounting the price back 4 years at 20% P0 = $5 / 1.20^4 = $2.41 it can get more complicated, orginially we assumed that the dividend was zero for the first couple years but but what if it is growing and then it is constant...year 1-$1, year 2 - 2, year 3 - 2.50... we have to combine the original present value formula and the constant growth... P3 = D3 x (1+g) / (R-g) = 2.50 x 1.05 / (.10- .05) =52.50 then... =1/1.10 + 2/1.10^2 + 2.50/1.10^3 + 52.50/1.10^3 =43.88

staggering

with staggered elections only a small portion of the dictatorships are up for election at any one time. it makes it more difficult for a minority to elect a director because there are fewer directors to be elected at one time, it also makes takeover attempts less likely

Common stock valuation (present value)

you somehow know that a share of stock will be worth $70 in a year; you predict that the stock will pay a $10 dividend; you require a 25% return on your investment; PV = (D1+P1)/(1+r) present value = ($10+$70)/1.25 = $64 what is the price in period 1? we generally do not know, but we somehow know the price for period 2. given a predicted dividend in two periods, the stock price in one period would be P1=(D2+P2) / (1+R) if we were to substitute this expression for P1 into our expression for P0 we would have: P0= D1 / (1+R)^1 + D2 / (1+R)^2 + P2 / (1+R)^2 *the problem is that you can keep pushing the stock price out into the future. the present value of the stock is always essentially zero. The current price of stock can be written as the present value of the dividends beginning in one period and extending out forever.

Does the value of a share of stock depend on how long you expect to keep it?

No and yes. The theoretical value of stock depends on dividends - of which there are three ways to calculate. But there must also be a real capital gain (or loss) between buy and sell dates

Required Return

R = dividend yield + capital gains yield R = D1/P0 + g ex// stock is selling for $20/share, the next dividend will be $1/share, you think that it will grow by 10%. What return does this stock offer you? R = $1/20 +.10 =.05+.10 =15%