Lecture 9

Question 1

corporate equity capital = ?

Answer 1

financial capital supplied by the owners if a corporation

funds raised by issuing equity shares in a corporation

Question 2

stock certificate = ?

Answer 2

certificate showing an ownership claim of a specific company

Question 3

what does common stock represent?

Answer 3

ownership shares in a corporation

Question 4

what’s the purpose of the board of directors?

Answer 4

they oversee the firm on behalf of the shareholders and enforce the corporate charter

Question 5

do common stockholders have voting rights?

Answer 5

yes

common stockholders have voting rights over who’s appointed as board members and other important issues allowed by the corporate charter

Question 6

corporate charter = ?

Answer 6

a document to establish details regarding the governance, objectives, operations and other major details of the company

Question 7

how are common stockholders treated with regards to claims against assets and cash flow?

Answer 7

common stockholders get the lowest claim against assets and cash flow

they are paid after all other claims are paid out first

Question 8

how does common stock differ from a bond as a security?

Answer 8

bonds represent debt, whereas common stock represents ownership

bonds are obliged to be repaid regardless of bankruptcy, but common stockholders run the risk of the company not being able to repay for their investment

Question 9

is the par value of the price for which the stock was bought important to common stockholders?

Answer 9

no, par value is meaningless for common stock

this is because common stock doesn’t have a maturity date

due to going concern, we assume a company will continue to exist infinitely

Question 10

how can one profit from their stock in a company?

Answer 10

buy low, sell high (capital gains)

dividends (annual distributions to shareholders)

Question 11

what is the value of the dividends’ dependent on?

Answer 11

the company’s performance

Question 12

when/how are dividends paid?

Answer 12

dividends are paid out from after-tax earnings and cash flow

Question 13

for how long does a firm’s stock remain in existance?

Answer 13

until the firm goes bankrupt, merges with another firm or is acquired by another firm

Question 14

preferred stock = ?

Answer 14

an equity security that has preference, or a senior claim, to the earnings and assets over common stockholders

Question 15

do preferred stockholders have voting rights?

Answer 15

no

only common stockholders have voting rights

Question 16

does par value matter to preferred stockholders?

Answer 16

yes, as it can determine the fixed annual dividend (which is a percentage of par value)

Question 17

how are dividends for preferred stockholders stated?

Answer 17

as a dollar amount derived from the percentage of par value

Question 18

are dividends from preferred stockholders cumulative?

Answer 18

yes, this means they pile up if not paid in previous periods

Question 19

does a preferred stock mature?

Answer 19

no, the assumption is that the company will continue infinitely

unless it has a callable or convertible feature

Question 20

“last trade: $52.87” = ?

Answer 20

last time the stock was traded, it was traded at $52.87 per share

Question 21

“change: 1.15” = ?

Answer 21

the price of the stock rose $1.15 from the end of the previous day

Question 22

“52 week range: $39.72 - $54.07” = ?

Answer 22

in the last 52 weeks, the stock price has ranged from $39.72 to $54.07

Question 23

“volume (,000s): 133,227” = ?

Answer 23

133,227,000 shares of the firm were traded in the previous

Question 24

“P/E: 35.72” = ?

Answer 24

price to earnings ratio = price/earnings per share = 35.72

if price of last trade was $52.87, 52.87/EPS … EPS = $52.87/$35.72 = 1.48

Question 25

“dividend: $1.44” = ?

Answer 25

microsoft pay dividends at an annual rate of 1.44 per share to its owners

Question 26

“dividend yield: 2.72%” = ?

Answer 26

stock’s annual dividend/current price

1.44/52.87 = 2.72%

Question 27

what is the equation to calculate earnings per share (EPS)?

Answer 27

p/e ratio = price/earnings per share

earnings per share = price/pe ratio

EPS shows how much one earns for each share they have

Question 28

what is the equation to calculate dividend yield %?

Answer 28

stock’s annual dividend / current price

dividend yield is how much one earns per share from their dividends

Question 29

what is the equation for dividend payout ratio?

Answer 29

dividend per share/earnings per share

dividend payout ratio shows how much of one’s earnings from their shares arise from their dividends

Question 30

what does a dividend payout ratio of 97% show?

Answer 30

it shows that 97% of the firm’s net income goes towards issuing dividends

Question 31

what does dividend yield show?

Answer 31

the return an investor would get as a percentage of the price they paid for the stock

Question 32

how is the value of a stock derived?

Answer 32

the value of any stock should be equal to the present value of all future dividends/cash flows

Question 33

how is the value of a bond derived?

Answer 33

its equal to the present value of all future coupons/cash flows plus the principal amount

Question 34

why is it tough to estimate a stock price?

Answer 34

due to its indefinite life and the fact that future cash flows can be uncertain (as its dependent on the company’s performance)

the discount/compound rate over the timespan of the stock being in one’s possession is unknown

Question 35

equation for the valuation of stocks = ?

Answer 35

cf/(1+r) to the power of 1 +
cf/(1+r) to the power of 2 +
cf/(1+r) to the power of 3 etc…

Question 36

when valuing a stock what is the assumption with regards to dividends?

Answer 36

it’s assumed that dividends will be constant

Question 37

when payment is constant in price, what is it called?

Answer 37

a perpetuity

Question 38

perpetuity = ?

Answer 38

a security that pays constant periodic cash flows as long as the issuer exists

an indefinite annuity

Question 39

annuity = ?

Answer 39

constant cash flows for a specified/limited time period

Question 40

equation for finding the price of a stock = ?

Answer 40

p = d/r

price = dividend / interest rate

this is only with perpetuities

Question 41

if x corporation’s preferred stock currently pays a $2 dividend and investors want a 10% return on preferred stocks of similar risk, what’s the preferred stock’s value?

Answer 41

p = d/r

price = $2/10% = $20

Question 42

instead of square rooting a figure, what else can be done

Answer 42

to the power of 1/2

Question 43

constant dividend growth = ?

Answer 43

when dividend is expected to grow at a constant rate forever

Question 44

if a firm’s dividend grows at an annual rate of ‘g’%, what’s the equation?

Answer 44

dividend 1 = d(1+g) to the power of 1
dividend 2 = d(1+g) to the power of 2
dividend 3 = d(1+g) to the power of 3
dividend 4 = d(1+g) to the power of 4 etc…

Question 45

what is the equation for the valuation of a stock with constant growth dividends?

Answer 45

p = d(1+g)/(r-g)

Question 46

assume the cash dividend per share for XYZ company last year was $1.89 and annual growth rate of 8.5%. If investors want 12% return, what’s the PV?

Answer 46

D = $1.89, G = 8.5%, R = 12%

P = D/(R-G)

d(1+g)/(r-g)

1.89(1+0.085)/(0.12-0.085) = $58.59

Question 47

return = ?

Answer 47

periodic income and price changes

Question 48

dollar return = ?

Answer 48

stock price at the end of the month - stock price at the beginning of the month + dividends

Question 49

percentage return = ?

Answer 49

dollar return / stock price at the beginning of the month

Question 50

if Walgreen’s stock went from $33.63 per share to $34.31 at the end of the month and $0.04 in dividends were received, what is the dollar return and percentage return?

Answer 50

dollar return = 34.31-33.63+0.04 = $0.72

percentage return = 0.72/33.63 = 2.14% for the month

Question 51

average return (R) = ?

Answer 51

sum of returns / number of periods

Question 52

deviations = ?

Answer 52

periodic return minus the average return

Question 53

suppose we have 3 annual returns, 5%, 11%, -4%

average return = ?

Answer 53

(5% + 11% -4%) / 3 = 4%

deviation for each annual return
5% - 4% = 1%
11% - 4% = 7%
-4% - 4% = -8%

sum of the deviations
1% + 7% - 8% = 0%

Question 54

variance = ?

Answer 54

summing the squared deviations / (n-1)

e.g., deviations were 1%, 7%, -8%, square all of them and add them, then divide the sum by 3-1 (2) = 0.0057 = the variance

Question 55

standard deviation = ?

Answer 55

the square root of the variance

e.g., square root of 0.0057 = 0.075 = 7.5% = standard deviation