Chapter 1 - EOC Solutions

Chapter 1 - EOC Solutions - Answers to End-of-Chapter...

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Unformatted text preview: Answers to End-of-Chapter Questions 1-1 When you purchase a stock, you expect to receive dividends plus capital gains. Not all stocks pay dividends immediately, but those corporations that do, typically pay dividends quarterly. Capital gains (losses) are received when the stock is sold. Stocks are risky, so you would not be certain that your expectations would be metas you would if you had purchased a U.S. Treasury security, which offers a guaranteed payment every 6 months plus repayment of the purchase price when the security matures. 1-2 If investors are more confident that Company As cash flows will be closer to their expected value than Company Bs cash flows, then investors will drive the stock price up for Company A. Consequently, Company A will have a higher stock price than Company B. 1-3 A firms intrinsic value is an estimate of a stocks true value based on accurate risk and return data. It can be estimated but not measured precisely. A stocks current price is its market price the value based on perceived but possibly incorrect information as seen by the marginal investor. From these definitions, you can see that a stocks true long-run value is more closely related to its intrinsic value rather than its current price. 1-4 Equilibrium is the situation where the actual market price equals the intrinsic value, so investors are indifferent between buying or selling a stock. If a stock is in equilibrium then there is no fundamental imbalance, hence no pressure for a change in the stocks price. At any given time, most stocks are reasonably close to their intrinsic values and thus are at or close to equilibrium. However, at times stock prices and equilibrium values are different, so stocks can be temporarily undervalued or overvalued. 1-5 If the three intrinsic value estimates for Stock X were different, I would have the most confidence in Company Xs CFOs estimate. Intrinsic values are strictly estimates, and different analysts with different data and different views of the future will form different estimates of the intrinsic value for any given stock. However, a firms managers have the best information about the companys future prospects, so managers estimates of intrinsic value are generally better than the estimates of outside investors....
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Chapter 1 - EOC Solutions - Answers to End-of-Chapter...

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