Equity Securities & Valuation Flashcards

Which valuation model discounts future dividends to determine the intrinsic value of a stock?

Answer: Dividend Discount Model

The Dividend Discount Model (DDM) values a stock by discounting expected future dividends at the required rate of return.

A stock has an expected dividend of $2.50, a required return of 10%, and a constant growth rate of 4%. What is its intrinsic value using the Gordon Growth Model?

Answer: $41.67

Using Gordon Growth Model: V = D1 / (r - g) = $2.50 / (0.10 - 0.04) = $2.50 / 0.06 = $41.67.

Which of the following best describes the Price-to-Book (P/B) ratio?

Answer: Market price divided by book value per share

The P/B ratio compares a company's market price to its book value per share, indicating how much investors pay relative to net assets.

What does a high Price-to-Earnings (P/E) ratio typically indicate about investor expectations?

Answer: Investors expect high future earnings growth

A high P/E ratio generally indicates that investors are willing to pay a premium, expecting strong future earnings growth from the company.

In a Discounted Cash Flow (DCF) analysis, which discount rate is most commonly used to value an entire firm?

Answer: Weighted Average Cost of Capital (WACC)

WACC reflects the blended cost of all capital sources (debt and equity) and is used to discount free cash flows to the firm in a DCF valuation.

Which type of equity security gives holders a priority claim on assets and dividends over common shareholders, but typically lacks voting rights?

Answer: Preferred stock

Preferred stock holders receive dividends before common shareholders and have priority in liquidation, but usually do not have voting rights.

Which ratio is calculated as Enterprise Value divided by EBITDA and is used to compare companies regardless of their capital structure?

Answer: EV/EBITDA multiple

EV/EBITDA is a capital-structure-neutral valuation multiple that allows comparison of companies with different levels of debt.