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30 Cards in this Set
- Front
- Back
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"The value of any financial asset equals..."
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The present value of all its future cash flows
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What are the cashflows for a bond and stock valuation?
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- Bond
Coupon + Face Value - Stock Dividend + Capital gains |
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Why is common stock more difficult to value than a bond?
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- There are no promised cash flows
- The life of the investment is forever, no maturity - The rate of return required by investors is unobservable |
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If an investment will pay £2 in one year, and you believe you can then sell the stock for £10. What is the maximum you would pay if requiring a 20% rate of return? HOW TO FIGURE THIS OUT?
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Price = (£10 + £2) / (1.2) = £10
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If an expected return is £5 in a divident by year 5. Figuring out its present value would involve discounting this single cashflow by...
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The power of 5 = 5 periods
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The stock price today is equal to the present value of...
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ALL future dividends.
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The stock price does not depend....
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on how long an investor intends to keep the stock, or how high the price might be in the distant future.
Stock price today = PV of all future dividends |
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What is the discount rate used for stock valuation?
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Required rate of return
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What discount rate is used to value bonds?
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YTM
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It is implicitly assumed that firms...
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Will not go bankrupt in the future.
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Why are the stocks in companies which currently
pay no dividend traded at positive prices? |
The company might pay larger dividends every few years, using the money to reinvest, grow, and provide a larger return to investors in the long term.
This is favourable in some cases. |
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Name the 3 types of dividend growth.
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- Zero growth
- Constant growth - Supernormal growth (differential growth) |
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What is constant dividend growth?
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When firms will:
- Increase the dividend by a constant percent every period (like many mature companies) Use the Dividend growth model (goron growth model): p0 = D1 / (r-g) MULTIPLE PERIODS: Just compound D1 by growth rate. p4 = D1*(1+g) / (r-g) Constant growth model conditions: - Dividend expected to grow at g forever - Stock price expected to grow at g forever - Expected capital gains yield is constant and equal to g Expected total return = dividend yield + g |
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What is dividend zero growth?
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When firms will:
- Pay a constant dividend forever - Price is computed using the perpeturity formula p0 = D / r The price of a zero growth stock will NEVER CHANGE - unless the required rate of return changes. Since future cash flows are constant, the value of zero growth stock is the PV of a perpetuity. p0 = D/r THE PRICE OF A ZERO GROWTH STOCK WILL NEVER CHANGE, UNLESS THE REQUIRED RATE OF RETURN CHANGES. Therefore, there is no reason to expect capital gains from this stock. |
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What is supernormal growth (differential growth)?
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When firms will:
- Produce unconsistent dividend growth initially, but settles down to constant dividend growth eventually. - This is a variation of constant dividend growth |
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If a question states "just paid", the dividend...
If a question states "expected to pay", the dividend... |
Just paid = extra cash early (like annuity due) = +1 period
Expected to pay = ordinary |
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What is the main aim when finding the growth rate in Gordon's constant growth model?
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Multiply out the brackets, and isolate numbers to one side, and g to another.
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What is differential growth?
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- Dividends grow at different rates and then will grow at a constant rate thereafter.
1) Calculate value when it starts paying dividends 2) Discount back to today. Always figure out the value for P one below d. Example: if trying to find value of d5, use p4. |
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For stocks, how do you figure out the required return?
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Required return = dividend yield + capital gains yield.
Dividend yield = (dividend income / stock price) Capital gains yield = (capital gains income) OR growth r |
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What does common stock mean?
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The stock has no special preference either in paying dividends or in bankruptcy.
Holders of common stock have shareholders voting rights -> Elect directors. |
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What is proxy voting in common stock?
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When stock owners transfer their vote to another party, in order to gain enough to affect important issues.
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Do all shares give one vote?
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Generally - however different classes of stock have different rights. Owners may issue nonvoting class of stock to make sure they maintain control.
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Are dividends a liability of the firm?
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No. A firm cannot go bankrupt for not declaring dividends.
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How are dividends taxed?
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Taxed as ordinary income for individuals.
Already gone through tax at a business level, through to profit, and then dividends. |
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Name 3 features of preferred stock?
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- Must be paid before common stockholders.
- Not a liability of the firm - Generally does not carry voting rights. |
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Name two stock markets.
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London Stock Exchange (LSE).
New York Stock Exchange (NYSE). |
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What is dividend policy?
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The decision to pay dividends now, or retain funds to reinvest.
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Name 2 reasons why a low dividend payout is good.
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1) Taxes - Higher tax bracket investors prefer capital gains, rather than low dividend payouts with their immediate tax consequences.
2) Flotation costs - Low payouts reduce the amount of capital that needs to be raised, lowering flotation costs (costs of issuing securities). |
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Name 2 reasons why a high dividend payout is good.
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1) Desire for current income - Regular usable cash.
2) Less risk that higher capital gains might not appear. Dividends become a significant part of ROI. |
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Give 1 ad and disad of paying dividends?
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1) Cash dividends underscore good results and support stock price.
2) Once established, making dividend cuts are hard without adversely affecting stock price. |
