Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
59 Cards in this Set
- Front
- Back
capital
|
long-term funds of a firm; all items on the right-hand side of the balance sheet, excluding current liabilities.
|
|
debt capital
|
all long-term borowing incurred by a firm, including bonds
|
|
equity capital
|
long-term funds provided by the firm's owners, the stockholders.
firm can obtain equity capital either internally (keeping retaining earning) or externally (selling of stocks) |
|
The Nature of Equity Capital: Voice in Management
|
Unlike bondholders and other credit holders, holders of equity capital are owners of the
firm. • Common equity holders have voting rights that permit them to elect the firm’s board of directors and to vote on special issues. • Bondholders and preferred stockholders receive no such privileges. |
|
The Nature of Equity Capital: Claims on Income & Assets
|
Equity holders are have a residual claim on the firm’s income and assets.
• Their claims can not be paid until the claims of all creditors, including both interest and principle payments on debt have been satisfied. • Because equity holders are the last to receive distributions, they expect greater returns to compensate them for the additional risk they bear. |
|
The Nature of Equity Capital: Maturity
|
Unlike debt, equity capital is a permanent form of financing.
• Equity has no maturity date and never has to be repaid by the firm. |
|
The Nature of Equity Capital: Tax Treatment
|
While interest paid to bondholders is tax-deductible to the issuing firm, dividends paid to
preferred and common stockholders of the corporation is not. • In effect, this further lowers the cost of debt relative to the cost of equity as a source of financing to the firm. |
|
Common Stock
|
Common stockholders, who are sometimes referred to as residual owners or residual
claimants, are the true owners of the firm. • As residual owners, common stockholders receive what is left—the residual—after all other claims on the firms income and assets have been satisfied. • Because of this uncertain position, common stockholders expect to be compensated with adequate dividends and ultimately, capital gains. |
|
Common Stock: Ownership
|
The common stock of a firm can be privately owned by an individual, closely owned by
a small group of investors, or publicly owned by a broad group of investors. • Typically, small corporations are privately or closely owned and if their shares are traded, this occurs infrequently and in small amounts. • Large corporations are typically publicly owned and have shares that are actively traded on major securities exchanges. |
|
Common Stock: Par Value
|
Unlike bonds, common stock may be sold without par value.
• The par value of a common stock is generally low ($1) and is a relatively useless value established in the firm’s corporate charter. • A low par value may be advantageous in states where certain corporate taxes are based on the par value of the stock. |
|
Common Stock: Preemptive Rights
|
A preemptive right allows common stockholders to maintain their proportionate
ownership in a corporation when new shares are issued. • This allows existing shareholders to maintain voting control and protect against the dilution of their ownership. • In a rights offering, the firm grants rights to its existing shareholders, which permits them to purchase additional shares at a price below the current price. |
|
rights offering,
|
the firm grants rights to its existing shareholders, which permits
them to purchase additional shares at a price below the current price. |
|
Authorized shares
|
are the number of shares of common stock that a firm’s corporate
charter allows. |
|
Outstanding shares
|
are the number of shares of common stock held by the public.
|
|
Treasury stock
|
is the number of outstanding shares that have been purchased by the
firm. |
|
Issued shares
|
are the number of shares that have been put into circulation and includes
both outstanding shares and treasury stock. |
|
Common Stock: Voting Rights
|
Each share of common stock entitles its holder to one vote in the election of directors
and on special issues. • Votes are generally assignable and may be cast at the annual stockholders meeting. • Many firms have issued two or more classes of stock differing mainly in having unequal voting rights. • Usually, class A common stock is designated as nonvoting while class B is designated as voting. • Because most shareholders do not attend the annual meeting to vote, they may sign a proxy statement giving their votes to another party. • Occasionally, when the firm is widely owned, outsiders may wage a proxy battle to unseat existing management and gain control |
|
supervoting shares
|
where in the case of a hostile takeover, the company give out supervoting power to the insiders so that the othersider having one vote per share will be unable to take over the company.
|
|
proxy statement
|
in the absent to vote, a stockholder can transfer their vote to another party.
|
|
Common Stock: Dividends
|
Payment of dividends is at the discretion of the board of directors.
• Dividends may be made in cash, additional shares of stock, and even merchandise. • Because stockholders are residual claimants—they receive dividend payments only after all claims have been settled with the government, creditors, and preferred stockholders. |
|
Preferred stock
|
is an equity instrument that usually pays a fixed dividend and has a
prior claim on the firm’s earnings and assets in case of liquidation. • The dividend is expressed as either a dollar amount or as a percentage of its par value. • Therefore, unlike common stock a preferred stock’s par value may have real significance. because of certain privileges, it makes them senior to common stockholders. In general, and arrearage must be paid before common stockholders receive a dividend. |
|
no-par preferred stock
|
preferred stock with no stated face value but with a stated annual dollar dividend
|
|
preferred stock:
cumlative |
preferred stock for which al passes (unpaid) dividents in arrears, along with the current divident, must be paid before dividents can be paid to common stockholders.
|
|
preferred stock:
noncumlative |
prefeered stock for which passed (unpaid) dividends do not accumulate
|
|
participating preferred stock
|
allows preferred stockholders to participate with
common stockholders in the receipt of dividends beyond a specified amount |
|
preferred stocks...features
|
Preferred stocks are also often referred to as hybrid securities because they possess the
characteristics of both common stocks and bonds. • Preferred stocks are like common stock because they are perpetual securities with no maturity date. • Preferred stocks are like bonds because they are fixed income securities. Dividends never change. • Because preferred stocks are perpetual, many have call features which give the issuing firm the option to retire them should the need or advantage arise. • In addition, some preferred stocks have mandatory sinking funds which allow the firm to retire the issue over time. |
|
Issuing Common Stock
|
Initial financing for most firms typically comes from a firm’s original founders in the
form of a common stock investment. • Early stage debt or equity investors are unlikely to make an investment in a firm unless the founders also have a personal stake in the business. • Initial non-founder financing usually comes first from private equity investors. • After establishing itself, a firm will often “go public” by issuing shares of stock to a much broader group. they have to make a profit first to prove to shareholders that they are making money before they go public. |
|
Venture Capital
|
privately raised external equity captial uses to fund early-stage firms with attractive growht prospects.
Initial equity financing privately raised by startup or early stage businesses comes from venture capital. |
|
Venture capitalists
|
those who provides venture capital
are usually formal businesses that maintain strong oversight over firms they invest in and have clearly defined exit strategies. |
|
Angel investors
|
weathly individual investors who do not operate as a business but invest in promising early-stage companies in exchange for a portion of the firm's equity
|
|
organization of institutional venture capital investors:
small business investment companies (SBIC) |
borrowing form gov.
corporations chartered by the federal gov. that can borrow at attractive rates from the U.S. Treasury |
|
organization of institutional venture capital investors:
financial VC funds |
borrowing from financial firms
subsidiaries of finanical institutions, particularly banks, set up to help young firms grow and hope that the starting company becomes a major customers of the institution |
|
organization of institutional venture capital investors:
comporate VC funds |
borrowing from non-financial firms
firms established by nonfinancial firms, typically to gain access to new technologies that the corporation can access to further its own growth |
|
organization of institutional venture capital investors:
VC limited partnerships |
where the company provides the fund and is part of the company...they serve as the general partner
|
|
public offering or IPO
|
in which it offers its shares for sale to the general public (our
focus). IPOs are typically made by small, fast-growing companies that either: • require additional capital to continue expanding, or • have met a milestone for going public that was established in a contract to obtain VC funding. |
|
rights offering,
|
in which new shares are sold to existing shareholders.
|
|
private placement
|
in which the firm sells new securities directly to an investor or a
group of investors. |
|
underwriting
|
the role of the investment banker in bearing the risk of reselling, at a profit, the securities purchased form an issuing corporation at an agreed-on price
After the underwriter sets the terms, the SEC must approve the offering. |
|
investment banker
|
responsible for promoting the stock and selling its shares.
financial intermediary that specializes in selling new ecurity issues and advising firms with regard to major financial transactions |
|
prospectus
|
file to SEC describing the key aspects of the issue, issuer, its management and finanical position
|
|
red herring
|
While waiting for approval, prospective investors can review the firm’s red herring,
which is a preliminary prospectus. |
|
quiet period
|
during which there are restrictions on what company officials may say about the company... purpose is to make sure that all protential investors have access to the same information about the company
|
|
investment banker:
road show |
Investment bankers and company officials promote the company through a road show, a
series of presentations to potential investors throughout the country and sometimes overseas. |
|
Underwriting syndicates
|
are typically formed when companies bring large issues to the
market. • Each investment banker in the syndicate normally underwrites a portion of the issue in order to reduce the risk of loss for any single firm and insure wider distribution of shares. • The syndicate does so by creating a selling group which distributes the shares to the investing public. costs for underwriting equity is highest, followed by preferred stock, and then bonds. • In percentage terms, costs can be as high as 17% for small stock offerings to as low as 1.6% for large bond issues. |
|
common stock valuation:
when to buy and when to sell |
Investors purchase shares when they feel they are undervalued and sell them when they
believe they are overvalued. |
|
equilibrium price—the market value
|
Investors base their investment decisions on their perceptions of an asset’s risk.
• In competitive markets, the interaction of many buyers and sellers result’s in an equilibrium price—the market value—for each security. • This price is reflective of all information available to market participants in making buy or sell investment decisions. a buyer would buy at a max price for a share and a seller would not sell lower than a set price. eventually, the market reaches equilibrium |
|
Common Stock Valuation:
Market Adjustment to New Information |
The process of market adjustment to new information can be viewed in terms of rates of
return. • Whenever investors find that the expected return is not equal to the required return, price adjustment will occur. • If expected return is greater than required return, investors will buy and bid up price until new equilibrium price is reached. • The opposite would occur if required return is greater than expected return. |
|
efficient market hypothesis
|
The efficient market hypothesis, which is the basic theory describing the behavior of a
“perfect” market specifically states: – Securities are typically in equilibrium, meaning they are fairly priced and their expected returns equal their required returns. – At any point in time, security prices full reflect all public information available about a firm and its securities and these prices react quickly to new information. – Because stocks are fairly priced, investors need not waste time trying to find and capitalize on improperly priced securities. |
|
behavioral financial
|
a growing body of research that focuses on investor behavior and it's impact on investment decision and stock prices. advocates are commonlyh referred to as behaviorists.
Although considerable evidence supports the concept of market efficiency, research collectively known as behavioral finance has begun to cast doubt on this notion. • Behavioral finance is a growing body of research that focuses on investor behavior and its impact on investment decisions and stock prices. • Throughout this book, we ignore both disbelievers and behaviorists and continue to assume market efficiency. |
|
common stock valuation
|
teh value of a share of common stock is equal to the present value of all future cash flows (dividends) that it is expected to provide over an infinite time horizon....
from a valuation viewpoint, only dividends are relevant...future dividends...when selling stock E(r) = D/P + g For example, if the firm’s $1 dividend on a $25 stock is expected to grow at 7%, the expected return is: E(r) = 1/25 + .07 = 11% |
|
Stock Valuation Models:
The Zero Growth Model |
The zero dividend growth model assumes that the stock will pay the same dividend each
year, year after year. an approach to divident valuation that assumes a constant, nongrowing divident stream Po= D1/rs Note that the zero growth model is also the appropriate valuation technique for valuing preferred stock. Example: The dividend of Denham Company, an established textile manufacturer, is expected to remain constant at $3 per share indefinitely. What is the value of Denham’s stock if the required return demanded by investors is 15%? P0 = $3/0.15 = $20 |
|
Stock Valuation Models:
Constant Growth Model (or the Gordon-growth model) |
The constant dividend growth model assumes that the stock will pay dividends that grow
at a constant rate each year—year after year forever. Po=D1/(ks-g) Po= value of common stock D = pre-share divident expected at end of year ks= required return on common stock |
|
Stock Valuation Models: Free Cash Flow Model
|
ideal when one is valuing firms that have no dividend history or are startups or hwne one is valuing an operating unit or division of a larger public company.
The free cash flow model is based on the same premise as the dividend valuation models except that we value the firm’s free cash flows rather than dividends. Vc = FCF1/(1+ra)^1 +FCF2/(1+ra)^2 +......+ Vc = value of the entire company FCFt = free cash flow expected at the end of year t ra = the firm's weighted average cost of capital The free cash flow valuation model estimates the value of the entire company and uses the cost of capital as the discount rate. • As a result, the value of the firm’s debt and preferred stock must be subtracted from the value of the company to estimate the value of equity. Vs= Vc-Vd-Vp vc= market value of the entire enterprise (all assets) Vs = common stock value Vd=market value of all firm's debt Vp= market value of preferred stock the appela of this approach is its focus on the free cash flow estimate rather than on forecast dividends because dividends are given out by the board...therefore, it's not the same every year. |
|
non-constant dividend growth or variable-growth
|
model assumes that the stock
will pay dividends that grow at one rate during one period, and at another rate in another year or thereafter. a dividend valuation approach that allows for a change in the dividend growth rate. |
|
Other Approaches to Stock Valuation:
book value per share |
the amount per share of common stock that would be received if all of the firm's assets were sold for their exact book (accounting) value and the proceeds remaining after paying all liabilities (including preferred stock) were divided among the common stockholders.
is the amount per share that would be received if all the firm’s assets were sold for their exact book value and if the proceeds remaining after paying all liabilities were divided among common stockholders. • This method lacks sophistication and its reliance on historical balance sheet data ignores the firm’s earnings potential and lacks any true relationship to the firm’s value in the marketplace. this method lacks sophistication and can be criticized on the basis of its reliance on historical balance sheet data. it ignores the firm's expected earnings potential and generally lacks any true relationship to the firm's value in the marketplace. |
|
Liquidation value per share
|
is the actual amount per share of common stock to be
received if all of the firm’s assets were sold for their market values, liabilities were paid, and any remaining funds were divided among common stockholders. • This measure is more realistic than book value because it is based on current market values of the firm’s assets. • However, it still fails to consider the earning power of those assets. the actual amount per share of common stock that would be received if all of the firm's assets were sold for their market value, liabilities (including preferred stock) were paid, and any remaining money were divided among the common stockholders. |
|
Other Approaches to Stock Valuation:
Price/Earnings (P/E) Multiples |
Some stocks pay no dividends—using P/E ratios are one way to evaluate a stock under
these circumstances. • The model may be written as: P0 = (EPSt+1) X (Industry Average P/E) For example, Lamar’s expected EPS is $2.60/share and the industry average P/E multiple is 7, then P0 = $2.60 X 7 = $18.20/share. it is also helpful in valuing firms that are not publicly trade. it is superior than book or liquidation value because it considers expected earnings. a popular technique used to estimate the firm's share value; calculated by multiplying the firm's expected earnings per share (EPS) by the average price/earnings (P/E) ratio for the industry. |
|
Decision Making and Common Stock Value
|
Valuation equations measure the stock value at a point in time based on expected return
and risk. • Any decisions of the financial manager that affect these variables can cause the value of the firm to change as shown in the Figure below. |
|
common stock valuation equation
|
zero-growth model
constant-growth model free cash flow valuation model book value liquidation value P/E multiples |