Principle of Managerial Finance
Chapter 7
Stock Valuation
Instructor’s Resources
Overview
This chapter continues on the valuation process introduced in Chapter 6 for bonds. Models for valuing preferred and common stock are presented. For common stock, the zero growth, constant growth, and variable growth models are examined. The relationship between stock valuation and efficient markets is presented. The role of venture capitalists and investment bankers is also discussed. The free cash flow model is explained and compared with the dividend discount models. Other approaches to common stock valuation and their shortcomings are explained. The chapter ends with a discussion of the interrelationship between financial decisions, expected return, risk, and a firm’s value.
Study Guide
Suggested Study Guide examples for classroom presentation:
Example
Topic
1
Constant growth rate model
4
Mixed growth rates
Suggested Answer to Chapter Opening Critical
Thinking Question
How might the owners of a closely held company react to an initial public offering when the stock’s value immediately rises significantly above its initial offering price?
Setting the proper price for an initial public offering is not an exact science. If the price is set too high, there will not be enough demand for the stock. Set too low, the stock price will likely rise immediately after the IPO. While it will please all of the new shareholders, the original owners of the company will have left too much on the table and may feel that the stock underwriters did not do an adequate job of pricing the IPO.
Answers to Review Questions
1. Equity capital is permanent capital representing ownership, while debt capital represents a loan that must be repaid at some future date. The holders of equity capital receive a claim on the income and assets of the firm that is secondary to the claims of the firm’s creditors. Suppliers of debt must receive all interest owed prior to any distribution to equity holders, and in
Stock Valuation
Instructor’s Resources
Overview
This chapter continues on the valuation process introduced in Chapter 6 for bonds. Models for valuing preferred and common stock are presented. For common stock, the zero growth, constant growth, and variable growth models are examined. The relationship between stock valuation and efficient markets is presented. The role of venture capitalists and investment bankers is also discussed. The free cash flow model is explained and compared with the dividend discount models. Other approaches to common stock valuation and their shortcomings are explained. The chapter ends with a discussion of the interrelationship between financial decisions, expected return, risk, and a firm’s value.
Study Guide
Suggested Study Guide examples for classroom presentation:
Example
Topic
1
Constant growth rate model
4
Mixed growth rates
Suggested Answer to Chapter Opening Critical
Thinking Question
How might the owners of a closely held company react to an initial public offering when the stock’s value immediately rises significantly above its initial offering price?
Setting the proper price for an initial public offering is not an exact science. If the price is set too high, there will not be enough demand for the stock. Set too low, the stock price will likely rise immediately after the IPO. While it will please all of the new shareholders, the original owners of the company will have left too much on the table and may feel that the stock underwriters did not do an adequate job of pricing the IPO.
Answers to Review Questions
1. Equity capital is permanent capital representing ownership, while debt capital represents a loan that must be repaid at some future date. The holders of equity capital receive a claim on the income and assets of the firm that is secondary to the claims of the firm’s creditors. Suppliers of debt must receive all interest owed prior to any distribution to equity holders, and in