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7 Cards in this Set

  • Front
  • Back

Determinants of of intrinsic value and stock prices

1. Managerial actions, economic environment, taxes, and political climate relate to:

a. "true" investor cash flows

b. "true" risk

c. perceived investor cash flows

d. perceived risk

2. true investor cash flows and true risk relates to the stock's intrinsic value

3. perceived investor cash flows and perceived risk relate to the stock's market price

4. Market equilibrium is achieved when intrinsic value=stock price.

Control of the firm

1. Stockholders, particularly common ones, have rights and privileges as owners of a corporation

2. Stockholders elect directors, which elects management

3. In small firms, major stockholder usually is the president and chair of the board of directors, while in big firms management owns some stock, but is insufficient to give them voting control, thus making them more readily removable by the firm's stockholders.

4. annual election of directors

5. 1 vote per share

6. Managers without 50% of firm's stock are concerned about proxy fights and takeovers and have persuaded stockholders to:

a. to elect only 1/3 of directors each rather than all

b. require 75% of stockholders to approve a merger

c. to vote in a poison pill provision that would allow the stockholders of a firm that is taken over to buy shares in the second firm at a reduced price.

8. Managers cite concerns of firm being picked up at bargain price, but really are concerned about themselves

9. Countered by institutional investors

10. Manager pay contentious issue

11. Manager compensation packages made transparent

12. Rulings have helped keep management focused on maximizing shareholder wealth.

Dividends vs Growth

1. Dividends are paid out of earnings

2. Therefore, growth in dividends requires growth in earnings

3.Earnings growth in the long run occurs primarily because firms retain earnings and reinvest them in the business

4. Therefore, the higher percentage of earnings retained, the higher the growth rate.

5. Next year's earnings= prior earnings+(ROE*Retained earnings)

Next year's dividends: payout ratio*next year's earnings

Growth rate: (1-payout ratio)ROE

In the long run growth in dividends depends primarily on the firm's payout ratio and its ROE.

Which is better: Current dividends or growth?

1. Firm cannot provide both a relatively high dividend and high growth rate.

2. Answer is not clear as to what stockholders prefer or is better; some stockholders prefer current dividends while others prefer more growth

3. Empirical studies have been unable to determine which strategy is better for maximizing a firm's stock price

4. Thus management must decide on the basis of judgment rather than mathematical formulas

5. If firm has exceptionally good investment opportunities, shareholders should prefer growth; whereas, if they the investment opportunities are poor, shareholders should prefer a higher dividend payout.

Required conditions for the constant growth model

Required rate of return must be higher than growth rate.

If not, than you will end up with a negative stock price, which is nonsensical, or an infinitely high stock price.

Constant growth model not appropriate if growth is nonconstant.

Intrinsic value vs stock price

Stock price:
1. Simply stock's market price
2. Can be easily observed for publicly traded companies

Intrinsic value:
1. represents the true value of the company's stock
2. cannot be easily observed

3. Must be estimated.
Why companies and investors care about intrinsic value

1. When investing in common stock, one's goal is to purchase stocks that are undervalued(stock's price below intrinsic value) and avoid stocks that are overvalued

2. Managers need to know how alternative actions are likely to affect stock prices

3. Managers should consider whether their stock is undervalued or overvalued before making decisions, such as the decision of issuing new shares if the stock is undervalued whereby an estimate of intrinsic value is important

4. Two models that estimate intrinsic value:

a. discounted dividend model

b. corporate valuation model