...Corporate Finance 1. Time value of money This concept discuss about the future value and the present value of money. For example a dollar today has more value than the dollar you will be earning in the future. Time value of money is a very important concept because it will help make decision on how much to save today to have a certain amount of saving for retirement in future. Interest rate and a time line also plays an important role in analyzing the time value of money. For Individuals the implications can be seen when deciding how much to save for retirement, valuing stocks when doing a personal investment or when calculating loan repayment schedule. For a corporation time value of money concept comes in to play when evaluating a project financial viability, when making new investment in plant and machinery and when investing in stocks and bonds. 2. Bonds I was able to learn about the types of bonds issued in the market and the risk associated with the bond market, pricing of the bonds, relationship between bond price and interest rate. A bond is a long term debt instrument issued by a corporate or a government in order to raise capital. This is a contract under which the borrower (a corporate or a government) agrees to make a payment of principle and interest on a specific future date to the holder of the bond. Corporate Bond, Treasury bond, high-yield corporate bonds (low quality also known as junk bonds), foreign bonds, mortgage-backed bonds and municipal...
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...Third Pass Value CHAPTER 7 PART 2 5 The Time Value of Money 6 Valuing Bonds 7 Valuing Stocks 7.1 Stocks and Stock Markets 7.2 Market Values, Book Values, and Liquidation Values 7.3 Valuing Common Stocks 7.4 Simplifying the Dividend Discount Model 7.5 Growth Stocks and Income Stocks 7.6 There Are No Free Lunches on Bay Street 7.7 Market Anomalies and Behavioural Finance 7.8 Summary 8 Net Present Value and Other Investment Criteria 9 Using Discounted Cash Flow Analysis to Make Investment Decisions 10 Project Analysis Valuing Stocks LEARNING OBJECTIVES After studying this chapter, you should be able to: LO1 LO2 LO3 LO4 LO5 Interpret stock trading information found on financial Web sites. Calculate the present value of a stock given forecasts of future dividends and future stock price. Use stock valuation formulas to infer the expected rate of return on a common stock. Interpret price-earnings ratios. Explain what professionals mean when they say that “there are no free lunches on Bay Street.” bre0089X_ch07_219-261.indd 219 31/01/12 11:32 AM Third Pass At the Toronto Stock Exchange and many other stock exchanges, all of the stock trading is done electronically, using computers. © James Leynse/Corbis. A corporation can raise cash to fund its investments by borrowing or by selling new shares of common stock to investors. If it borrows, it has a fixed obligation to repay the lender. If it issues shares, there is no fixed obligation, but the new...
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...Chapter 08 - Stock Valuation CHAPTER 8 STOCK VALUATION Answers to Concepts Review and Critical Thinking Questions 1. The value of any investment depends on the present value of its cash flows; i.e., what investors will actually receive. The cash flows from a share of stock are the dividends. Investors believe the company will eventually start paying dividends (or be sold to another company). In general, companies that need the cash will often forgo dividends since dividends are a cash expense. Young, growing companies with profitable investment opportunities are one example; another example is a company in financial distress. This question is examined in depth in a later chapter. The general method for valuing a share of stock is to find the present value of all expected future dividends. The dividend growth model presented in the text is only valid (a) if dividends are expected to occur forever, that is, the stock provides dividends in perpetuity, and (b) if a constant growth rate of dividends occurs forever. A violation of the first assumption might be a company that is expected to cease operations and dissolve itself some finite number of years from now. The stock of such a company would be valued by applying the general method of valuation explained in this chapter. A violation of the second assumption might be a start-up firm that isn’t currently paying any dividends but is expected to eventually start making dividend payments some number of years from now. This stock would...
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...Chapter 9 Stocks and Their Valuation Answers to End-of-Chapter Questions 9-1 a. The average investor of a firm traded on the NYSE is not really interested in maintaining his or her proportionate share of ownership and control. If the investor wanted to increase his or her ownership, the investor could simply buy more stock on the open market. Consequently, most investors are not concerned with whether new shares are sold directly (at about market prices) or through rights offerings. However, if a rights offering is being used to effect a stock split, or if it is being used to reduce the underwriting cost of an issue (by substantial underpricing), the preemptive right may well be beneficial to the firm and to its stockholders. b. The preemptive right is clearly important to the stockholders of closely held (private) firms whose owners are interested in maintaining their relative control positions. 9-2 No. The correct equation has D1 in the numerator and a minus sign in the denominator. 9-3 Yes. If a company decides to increase its payout ratio, then the dividend yield component will rise, but the expected long-term capital gains yield will decline. 9-4 Yes. The value of a share of stock is the PV of its expected future dividends. If the two investors expect the same future dividend stream, and they agree on the stock’s riskiness, then they should reach similar conclusions as to the stock’s value. 9-5 A perpetual bond is similar to a no-growth...
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...7 Stocks, Stock Valuation, and Stock Market Equilibrium ------------------------------------------------- ANSWERS TO END-OF-CHAPTER QUESTIONS 7-1 a. A proxy is a document giving one person the authority to act for another, typically the power to vote shares of common stock. If earnings are poor and stockholders are dissatisfied, an outside group may solicit the proxies in an effort to overthrow management and take control of the business, known as a proxy fight. The preemptive right gives the current shareholders the right to purchase any new shares issued in proportion to their current holdings. The preemptive right may or may not be required by state law. When granted, the preemptive right enables current owners to maintain their proportionate share of ownership and control of the business. It also prevents the sale of shares at low prices to new stockholders which would dilute the value of the previously issued shares. Classified stock is sometimes created by a firm to meet special needs and circumstances. Generally, when special classifications of stock are used, one type is designated “Class A”, another as “Class B”, and so on. Class A might be entitled to receive dividends before dividends can be paid on Class B stock. Class B might have the exclusive right to vote. Founders’ shares are stock owned by the firm’s founders that have sole voting rights but restricted dividends for a specified number of years. b. Estimated value () is the...
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...Reporting and Analyzing Stockholders’ Equity Study Objectives • • • • • • • • • Identify and discuss the major characteristics of a corporation. Understand the Components of Stockholders’ Equity. Record the issuance of common stock. Explain the accounting for the purchase of treasury stock. Differentiate preferred stock from common stock. Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits. Identify the items that affect retained earnings. Prepare a comprehensive stockholders' equity section. Evaluate a corporation's dividend and earnings performance from a stockholder's perspective. Chapter Outline Study Objective 1 - Identify and Discuss the Major Characteristics of a Corporation 1. A corporation is a. a legal entity created by law b. a corporation has most of the rights and privileges of a person. c. Corporations may be classified in a variety of ways. Two common classifications are i. by purpose ii. by ownership. 1. Classification by ownership differentiates publicly held or privately held; a. A publicly held corporation is regularly traded on a national securities market and may have thousands of stockholders. b. A privately held corporation, often referred to as a closely held corporation, does not offer its stock for sale to the general public and may have only a few stockholders. 2. Distinguishing Corporations from proprietorships and partnerships. a. Separate legal existence: i. An entity separate and distinct from owners. ii...
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...shareholders of distributed earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to raise capital, and unlimited life. 2. Evaluate the following statement: Managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long- term profits. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, both short-term and long-term. If this is correct, then the statement is false. 3. Could a company’s cash flow to stockholders be negative in a given year? Explain how this might come about. If a company raises more money from selling stock than it pays in dividends in a particular period its cash flow to stockholders will be negative. If a company borrows more than it pays in interest, its cash flow to creditors will be negative. 4. Jetson Spacecraft Corp. shows the following information on its 2009 income statement: sales $ 196,000; costs $ 104,000; other expenses $ 6,800; depreciation expense $ 9,100; interest expense $ 14,800; taxes $ 21,455; dividends $ 10,400. In addition, you’re told that the firm issued $ 5,700 in new equity during 2009 and redeemed $ 7,300 in outstanding long- term debt. a. What is the 2009 operating cash flow? b. What is the 2009 cash flow to creditors? c. What is the 2009 cash flow to stockholders? To find the OCF, we first calculate net income...
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...Stock Valuation Using Online Data The goal of this exercise is to use the discounted cash flow model to estimate the intrinsic value of a particular stock, to perform sensitivity analysis, and to determine whether a stock is currently undervalued, overvalued, or appropriately valued. 1.) Find an estimate of the risk-free rate by using www.bloomberg.com. Use the yield to maturity for 30-year U.S. Treasury bond. Hit the markets tab, click on link to government bonds. Be sure not to use the coupon rate. The yield to maturity for the 30-year U.S. Treasury bond is 3.43 as of April 3, 2012 at 3:08 pm. | COUPON | MATURITY | PRICE/YIELD | PRICE/YIELD CHANGE | TIME | 30-Year | 3.125 | 02/15/2042 | 94-08+ / 3.43 | -1-28 / 0.104 | 15:58 | 2.) Value one share of Walgreen. Use the Yahoo! Finance site (Key statistics tab) to find the stock's beta and the next dividend paid (forward dividend). Be sure not to confuse the dividend with the dividend yield. Stock Price History | Beta: | 1.26 | Forward Annual Dividend Rate4: | 0.90 | 3.) Studies indicate that the market risk premium ranges from 4% to 8%. Assume a market risk premium of 6%. Using the data obtained in (1) and (2) use CAPM to determine the required rate of return for this stock. Rf + B (Rm - Rf) Required Return: 3.43 + 1.26 (6 – 3.43) = 6.67% 4.) Estimate the stock's future dividend growth rate. Go to the www.reuters.com website and click on markets and then stocks. Type in the name of Walgreens and select...
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...you borrow loans, you want to get the interest rate as low as you can since you’re borrowing money. The higher the rate, the more you have to pay; the lower the rate the less you have to pay. 3. AirJet Best Parts, Inc. has decided to take a $6,950,000 loan being offered by Regions Best at 8.6% APR for 5 years. What is the monthly payment amount on this loan? Do you agree with this decision? Explain your rationale. To find monthly payment for this loan we need to determine the Present Value of Annuity formula: C [(1-{11+rate}t)/rate] insert the numbers… C[(1-{11.0071666667}60)/.0071666667] PVA= 48.62687143 We now take $6,950,000 and divide it by 48.6287143 to find out our monthly payment C=6,950,000/48.6287143 C= $142,925 After calculating these numbers, I’ve concluded that it’s a good decision for AirJet Best Parts, Inc. to go with this loan. With a high APR rate and a higher loan payment of $142,925, I get a good monthly payment. Evaluating Competitor’s Stock 1. Using the dividend growth model and assuming a dividend growth rate of 5%, what is the rate of return for one of three key competitors? Use Yahoo Finance to obtain the latest...
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...Common Stock - Ownership shares in a publicly held corporation. * Secondary Market - market in which already issued securities are traded by investors. * Dividend - Periodic cash distribution from the firm to the shareholders. * P/E Ratio - Price per share divided by earnings per share, most commonly used for valuation. * Book Value - Net worth of the firm according to the balance sheet. * Liquidation Value - Net proceeds that would be realized by selling the firm’s assets and paying off its creditors. * Market Value Balance Sheet - Financial statement that uses market value of assets and liabilities. * Preferred shares – pay a fixed dividend, can be omitted Dividends paid before common shares Equity on the balance sheet No voting rights, as with common stock * Expected Return - % yield forecasted from an investment over a period of time, also known as ‘the cost of equity capital’ * Dividend Discount Model – finds share value by adding discounted future dividend payments and eventual selling price. * * If no growth is forecasted, and the stock is to be held forever, value the stock as a perpetuity: * Constant Growth DDM – similar to dividend growth model, but dividends grow at a constant rate. * If a firm pays lower dividend and reinvests funds, may lead to higher future dividends, leading to a higher stock price...
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...CHAPTER 7 STOCKS AND THEIR VALUATION (Difficulty: E = Easy, M = Medium, and T = Tough) Multiple Choice: Conceptual Easy: Required return Answer: d Diff: E [i]. If the expected rate of return on a stock exceeds the required rate, a. The stock is experiencing supernormal growth. b. The stock should be sold. c. The company is probably not trying to maximize price per share. d. The stock is a good buy. e. Dividends are not being declared. Constant growth model Answer: a Diff: E [ii]. Which of the following statements is most correct? a. The constant growth model takes into consideration the capital gains earned on a stock. b. It is appropriate to use the constant growth model to estimate stock value even if the growth rate never becomes constant. c. Two firms with the same dividend and growth rate must also have the same stock price. d. Statements a and c are correct. e. All of the statements above are correct. Constant growth model Answer: a Diff: E [iii]. Which of the following statements is most correct. a. The stock valuation model, P0 = D1/(rs - g), can be used for firms which have negative growth rates. b. If a stock has a required rate of return rs = 12 percent, and its dividend grows at a constant rate of 5 percent, this implies that the stock’s dividend yield is 5 percent. c. The price of a stock is the present value of all expected future...
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...CHAPTER 7 STOCKS AND THEIR VALUATION (Difficulty: E = Easy, M = Medium, and T = Tough) Multiple Choice: Conceptual Easy: Required return Answer: d Diff: E [i]. If the expected rate of return on a stock exceeds the required rate, a. The stock is experiencing supernormal growth. b. The stock should be sold. c. The company is probably not trying to maximize price per share. d. The stock is a good buy. e. Dividends are not being declared. Constant growth model Answer: a Diff: E [ii]. Which of the following statements is most correct? a. The constant growth model takes into consideration the capital gains earned on a stock. b. It is appropriate to use the constant growth model to estimate stock value even if the growth rate never becomes constant. c. Two firms with the same dividend and growth rate must also have the same stock price. d. Statements a and c are correct. e. All of the statements above are correct. Constant growth model Answer: a Diff: E [iii]. Which of the following statements is most correct. a. The stock valuation model, P0 = D1/(rs - g), can be used for firms which have negative growth rates. b. If a stock has a required rate of return rs = 12 percent, and its dividend grows at a constant rate of 5 percent, this implies that the stock’s dividend yield is 5 percent. c. The price of a stock is the present value of all expected future...
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...FINS1613 Business Finance Semester 2 – 2009 Version 1.0.0 12th October 2009 Contents Page 3 Page 7 Page 10 Page 14 Page 18 Page 23 Page 26 Page 29 Page 32 Page 38 Page 42 Basic Concepts Introduction to Financial Mathematics The Valuation of a Firm’s Securities Capital Budgeting Capital Budgeting Applications – Part 1 Capital Budgeting Applications – Part 2 Risk and Return The Capital Asset Pricing Model Cost of Capital and Raising Capital Capital Structure Dividend Policy Note: This course has prerequisites and, as such, these notes are written assuming that you have sound knowledge from those prerequisite courses. Business Finance– Semester 2 2009 2 Basic Concepts Basic Concepts Background Before we delve into the harder components of business finance, it is imperative that we learn the basics first. Types of Business Forms If you have previously studied Business Studies for the HSC, you can skip this section. Businesses are usually formed based on a set structure. The most common of these are: • Sole Proprietorships This is where the business is owned by a single person. It is very simple, fast to establish and generally has very minimal government regulations. The owner gets to keep all the profits himself so there is incentive to work harder. The downside is that it has unlimited liability (where if the business goes bankrupt, everything the owner owns can be taken by creditors). There is also difficulty in raising large sums of money as you are a single...
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...Shareholders An investor can be from a number of different sources. On one hand, they could be a major corporation that not only sells its own stock, but also owns shares in other companies. On the other hand, they could be a first time investor looking to exercise some extra money and see if they can turn a profit. Either way, the stock market can be a confusing and intimidating place. Every investor needs to have a basic understand of where the shares of stock are coming from and what exactly is involved. To help with this elementary understanding, we will observe and address few questions. 1. What are the distinguishing characteristics between different shares of stock? 2. What are the benefits to the investor? 3. What is par value and why is it important? What Are The Distinguishing Characteristics Between Different Shares of Stock To fully understand and grasp the full concept we need to break it all down into bite sized, comprehensible pieces and the New Oxford American Dictionary helps to provide these definitions. In order to become a shareholder in a company an individual needs to purchase shares of stock. A share is considered to be a portion of a larger amount that is divided among a number of other shareholders that also contribute to the company. Stock is the capital that is being raised by a company through issuing the shares to the general public or to other corporations. The individuals...
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...CHAPTER 7 STOCKS AND THEIR VALUATION (Difficulty: E = Easy, M = Medium, and T = Tough) Multiple Choice: Conceptual Easy: Required return Answer: d Diff: E [i]. If the expected rate of return on a stock exceeds the required rate, a. The stock is experiencing supernormal growth. b. The stock should be sold. c. The company is probably not trying to maximize price per share. d. The stock is a good buy. e. Dividends are not being declared. Constant growth model Answer: a Diff: E [ii]. Which of the following statements is most correct? a. The constant growth model takes into consideration the capital gains earned on a stock. b. It is appropriate to use the constant growth model to estimate stock value even if the growth rate never becomes constant. c. Two firms with the same dividend and growth rate must also have the same stock price. d. Statements a and c are correct. e. All of the statements above are correct. Constant growth model Answer: a Diff: E [iii]. Which of the following statements is most correct. a. The stock valuation model, P0 = D1/(rs - g), can be used for firms which have negative growth rates. b. If a stock has a required rate of return rs = 12 percent, and its dividend grows at a constant rate of 5 percent, this implies that the stock’s dividend yield is 5 percent. c. The price of a stock is the present value of all expected future...
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