Ch07_Equity_Markets_and_Stock_Valuation

What are the two main ways stockholders receive cash from their investments?

Cash can be received through dividends (dollar income) and selling shares (capital gains).

What is the dividend growth model used for?

To compute stock prices based on expected future dividends and their growth rate.

What does the Dividend Discount Model (DDM) assume about a firm's dividends?

It assumes dividends are expected future cash flows that can be discounted to present value.

How does common stock differ from bonds in terms of valuation difficulty?

Stocks are more difficult to value than bonds because their cash flows are not predetermined.

What happens to a stock's price under the constant dividend valuation model?

The price is computed using the perpetuity formula for expected constant dividends.

What was the primary stock valuation method during the early and mid-20th century?

The Dividend Discount Model (DDM) was considered the primary stock valuation method.

What is the formula for finding the required return on equity using the dividend growth model?

R = D1/P0 + g, where D1 is the expected dividend, P0 is the price, and g is the growth rate.

What does the Capital Gains Yield represent in the context of stock valuation?

It represents the expected growth rate of the stock's price.

What is one of the main features that differentiate common stock from preferred stock?

Common stockholders have voting rights while preferred stock generally does not.

How does cumulative voting differ from straight voting in corporate elections?

Cumulative voting allows shareholders to distribute their votes among candidates, while straight voting gives one vote per share in each election round.

What does it mean that dividends are not a liability of the firm until declared?

A firm cannot be bankrupt for failing to declare dividends, as they are not considered a business expense.

What criteria do analysts use to determine if a stock is overvalued or undervalued based on the P/E ratio?

If the P/E ratio is higher than normal, the stock is overvalued; if lower, it is undervalued.

In the context of stock valuation, what is a 'normal' P/E ratio?

The historical average P/E ratio of a firm or the industry average.

How is the stock price calculated using the price-to-earnings (P/E) ratio?

P = EPS x PE ratio.

What has influenced the decline of the Dividend Discount Model’s relevance?

The shift of companies toward reinvestment into growth rather than regular dividend payouts.

What key insight about dividends and corporate control is highlighted in the notes?

Shareholders control the corporation through the right to elect directors, demonstrating a unique form of corporate democracy.