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Chapter 1: Introduction to Stocks and Bonds

• Key Differences Between Stocks and Bonds

  • Buying stocks (e.g., Apple) does not have an end date; they can be held indefinitely (perpetuity).

  • Bonds have a specific maturity period (e.g., 10 or 20 years).

• Investment Returns from Stocks

  • Investors receive returns through:

    • Dividends: Payments made to shareholders, which can change (not obligatory).

    • Selling shares: Stock can be sold back to the company or to other investors.

• Valuation Example

  • If expecting a $2 dividend in one year, selling stock for $14, and requiring a return of 20%, calculate the present value.

• Valuation Formulas

  • Use future payments and discount to present value:

    • If holding for 2 years with $2 and a growing dividend of $2.10, the stock price must reflect all future dividends discounted to today.

• Dividend Types

  • Constant Dividend: A fixed dividend (e.g., $2 annually), commonly associated with preferred stocks.

  • Growing Perpetuity: Fixed dividend with a growth rate (e.g., $2 growing at 2% annually).

  • Super Normal Growth: Non-constant early dividends followed by a stable growth period.

  • Zero Growth: Fixed dividend (e.g., $2 annually) with no growth rate.

Chapter 2: Dividends and Stock Valuation

• Dividend Example

  • If stock pays a 0.5% quarterly dividend with a 10% required return, systematically calculate price using constant growth.

• Important Formulas

  • Ensure growth rate (g) is less than market return (r) for validity in price calculations using the perpetuity formula (P0 = D1 / (r - g)).

  • Analyze stock price behavior relative to growth rate. Higher growth leads to higher stock prices whereas increasing required return leads to lower prices.

• Dividend Growth Calculation

  • For a $2 dividend expected to grow 5% annually, calculate future dividends and their present value accordingly.

Chapter 3: Different Cash Flows

• Cash Flow Analysis

  • Follow structured calculations to determine stock prices based on dividend expectations and growth rates.

  • D1 represents dividends expected in one year; D5 would represent future dividends when approaching calculations for multiple periods.

Chapter 4: Present Value Formula

• Present Value Calculations

  • Apply perpetuity formulas to evaluate investments over time with varying dividend payouts.

  • Understand that dividend payments are not liabilities; companies decide if and when to distribute dividends.

• Shareholder Rights

  • Shareholders possess voting rights and prioritize dividend distributions among classes of stocks.

Chapter 5: Evaluating Projects

• Net Present Value (NPV)

  • A positive NPV indicates a beneficial investment; a negative NPV suggests against it.

  • Calculate expected cash flows and the costs of investments over time to determine their value.

• Decision Making Criteria

  • Time value of money is critical in determining project acceptance by discounting future benefits.

  • Examine benefits versus costs to optimize investment decisions.

Chapter 6: Accepting Projects

• Evaluation Methods

  • Payback methods analyze how long it takes to recover investments; discounted methods consider the time value of money.

  • Understand advantages and disadvantages of various valuation methods during project appraisal.

Chapter 7: Internal Rate of Return (IRR) and NPV

• IRR Concepts

  • IRR is the rate that makes NPV zero; accept projects where IRR exceeds required returns.

  • Multiple IRRs can exist if cash flow signs vary significantly.

• Comparison of Projects

  • Choose higher NPV projects and be cautious of using IRR in non-conventional cash flow situations.

Chapter 8: Conclusion

• Exam Preparation

  • Focus on chapters emphasizing NPV calculations and divergences for the upcoming exam.

  • Understand theoretical concepts, definitions, and practical applications to prepare effectively.