Exam 3 Study Guide Doug Smith Chapters 11 13 14 18 1 Calculate Holding Period Return Holding Period Return The total return received from holding an asset or portfolio of assets over a period of time general expressed as a percentage It is useful for comparing returns between investments held for different periods of time o Expected holding period Expected dividend yield expected rate of price appreciation current price all dividend by current price o The return on a stock investment comprises consists of cash dividends and capital gains or losses o Assuming a one year holding period o Expected dividend per share E D1 Price at the end of the year E P1 Current price of a share Po OR o Holding Period Return Income End of Period Value Initial Value 2 Dividend Payout Initial Value a Dividend Payout The percentage of earnings paid to shareholders in dividends b The dividend payout ratio is the percentage of a firm s net income or free cash flow paid out to shareholders as dividends c A financial ratio that shows how much a company pays out in dividends each year relative to its share price In the absence of any capital gains the dividend yield is the return on investment for a stock d o Dividend payout ratio provides an idea of how well earnings support the dividend payments 3 Security s intrinsic value a Intrinsic Value The present value of a firm s expected future net cash flows discounted by a risk adjusted required rate of return Intrinsic value denoted Vo is defined as the present value of all cash payments to the investor in the stock including dividends as well as the proceeds from the ultimate sale of the stock discounted at the appropriate risk adjusted interest rate k V 0 E D1 E P1 1 k o Dividends Dt o Sale price Pt o Intrinsic Value today time 0 is denoted Vo and for a one year holding 4 Calculate expected market price per share period may be found as o Market price per share of stock is a current measure of price not an accounting or historical measure of the value of the stock like the book value per share The market price per share is used to determine whether or not to purchase a stock o Market Price is the most recent price at which the stock was traded It does not guarantee that an investor will receive the same price upon buying the stock afterward o Market Price Per Share Net Income Preferred Dividends Number of Shares of Common Shares Outstanding o The market price per share and the current price at which the stock is being traded are not necessarily the same The current trading price is based on investor buying and selling behavior The market price per share is also called the intrinsic value of a share of stock or the actual value based on the actual variables taken from the company s financial statements 5 Stock valuation models a Fall into two categories absolute and relative valuation models i Absolute valuation models attempt to find the intrinsic or true value of an investment based only on fundamentals dividends cash flow and growth rate for a single company Dividend discount model DDM calculates true value of a firm based on the dividends the company pays its shareholders Reason for using dividends to value a company is that dividends represent the actual cash flows going to the shareholder thus valuing the present value of these cash flows should give you a value for how much the shares should be worth The beginning intrinsic formula is 1 V 0 t 1 Dt 1 k t V0 Intrinsic Value of Stock Dt Dividend in time t k required return Discounted cash flow model uses a firm s discounted future cash flows to value the business The big advantage of this approach is that it can be used with a wide variety of firms that don t pay dividends ii Relative valuation models operate by comparing the company in question to other similar companies These methods generally involve calculating multiples or ratios such as the price to earnings multiple and comparing them to the multiples of other comparable firms P E ratio focuses on the earnings of the company 6 Components of balance sheet income statement a Balance Sheet Total Assets Liabilities Shareholders Equity i Total Assets which are composed of Current Assets Long term Assets 1 Current Assets are assets that may be converted into cash sold or consumed within a year or less which usually includes Cash What a company has in its bank Short term investments expected to be sold within one year s time Accounts receivable this represents the money that is owed to the company for the goods and services it has provided to customers on credit Notes Receivable Net realizable Value what will be collected includes promissory notes short term loan that carries interest Maturity of notes receivable is generally longer than accounts receivable Inventory raw materials and items that are available for sale or are in the process of being made ready for sale Prepaid expenses these are payments that have been made for services that the company expects to receive in the near future Rent Insurance premiums and taxes 2 Long term assets assets that may not be converted into cash sold or consumed within a year or less Includes Investments investments that management does not expect to sell within the year Bonds common stock long term notes Fixed Assets these are durable physical properties used in operations that have a useful life longer than one year Machinery Equipment Buildings Land Other assets special classification for unusual items that cannot be included in one of the other asset categories Deferred charges long term prepaid expenses non current receivables and advances to subsidiaries Intangible Assets lack physical substance but provide economic rights and advantages patents franchises copyrights goodwill trademarks organization costs ii Total Liabilities which are composed of Current Liabilities and Long term 1 Current Liabilities debts that are due to be paid within one year Usually Liabilities includes Bank indebtedness amount that is owed to the bank in the short term bank line of credit Accounts payable this amount is owed to suppliers for products and services that are delivered but not paid for Wages payable salaries rent tax and utilities this amount is payable to employees landlords government and others Accrued liabilities accrued expenses these liabilities arise because an expense occurs in a period prior to the related cash payment customer prepayments dividends payables wages payable Notes payable short term loans this is an