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Unformatted text preview: ned companies. The company receives no new money
when sales are made in the secondary market. The primary market handles additional
shares sold by established, publicly owned companies. Companies can raise
additional capital by selling in this market. Going public is the act of selling stock to
the public at large by a closely held corporation or its principal stockholders, and this
market is often termed the initial public offering (IPO) market.
d. Intrinsic value ( P0 ) is the present value of the expected future cash flows. The
market price (P0) is the price at which an asset can be sold. Answers and Solutions: 7 - 1 e. The required rate of return on common stock, denoted by rs, is the minimum
acceptable rate of return considering both its riskiness and the returns available on
other investments. The expected rate of return, denoted by rs , is the rate of return
expected on a stock given its current price and expected future cash flows. If the
stock is in equilibrium, the required rate of return will equal the expected rate of
return. The realized (actual) rate of return, denoted by r s , is the rate of return that
was actually realized at the end of some holding period. Although expected and
required rates of return must always be positive, realized rates of return over some
periods may be negative.
f. The capital gains yield results from changing prices and is calculated as (P1 - P0)/P0,
where P0 is the beginning-of-period price and P1 is the end-of-period price. For a
constant growth stock, the capital gains yield is g, the constant growth rate. The
dividend yield on a stock can be defined as either the end-of-period dividend divided
by the beginning-of-period price, or the ratio of the current dividend to the current
price. Valuation formulas use the former definition. The expected total return, or
expected rate of return, is the expected capital gains yield plus the expected dividend
yield on a stock. The expected total return on a bond is the yield to maturity.
g. Normal, or constant, growth occurs when a firm¶s earnings and dividends grow at
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- Spring '12