Chapter 9- Stocks and Their Valuation_1

Chapter 9- Stocks and Their Valuation_1 - Arizona State...

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Arizona State University FINANCE 300 Fundamentals of Finance Chapter 9: Stocks and Their Valuation Instructor: Christian Ramirez Introduction In the previous chapter, you were introduced to bonds and bond valuation. In this chapter, we will study another source of financing for corporations. This other source of financing is called equity financing and is achieved through the issuance of stock. We will start with an overview of some of the most important features of common stock as well as stockholders rights. From there, we move on to describing the cash flows associated with a share of stock and then go on to develop the dividend growth model to find the value of common stock. We close out the chapter by analyzing a stock’s rate of return and the valuing of nonconstant growth stocks. Rights of Common Stockholders Stockholders are the owners of a corporation and they have the right to control this corporation. Stockholders elect directors, who, in turn, hire management to carry out their directive. Stockholders, therefore, control the corporation through the right to elect the directors. Only stockholders have this right. Each year an annual corporation meeting is held where directors are elected. In theory, a common share is worth one vote. The more shares someone has, the more vote he/she would be eligible to make. The directors that receive the most votes get elected. Proxies Proxies are used to grant authority to someone else to vote on behalf of the stockholder. For convenience, much of the voting in large public corporation is done by proxy. Thus, a proxy is a grant of authority by a shareholder allowing another individual to vote his/her shares. Large companies have sometimes millions of stockholders and it would be impractical to request the presence of every stockholder when elections take place. Therefore, stockholders typically transfer their right to vote to another person or group of stockholders by means of a proxy. It is very common for a group of disappointed stockholders to solicit proxies from other stockholders in an attempt to overthrow management and take control of the company. This is known as proxy fight . Another right conferred to stockholders is the right to purchase a majority of the outstanding stock of a company with the purpose of taking the full control of the firm.
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This action whereby a group of stockholders succeed in removing a firm’s management and taking control of the firm is called takeover. The preemptive right gives the common stockholders the right to purchase any additional shares issued by the firm based on the number of shares currently held by these stockholders. By doing this, existing stockholders are able to maintain their fractional ownership of a company by buying a proportional number of shares of any future issue of common stock. The purpose of this preemptive right is 1) to prevent management from issuing a large number of additional shares and purchasing these shares themselves with the intention of gaining control of the firm; 2) to protect stockholders against a dilution of
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This note was uploaded on 12/16/2009 for the course FIN 300 taught by Professor Olander during the Spring '08 term at ASU.

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Chapter 9- Stocks and Their Valuation_1 - Arizona State...

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