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What rights does ownership interest give stockholders?
Answer: Stockholders have the right to vote on issues brought before the stockholders, be the
residual claimant, that is, receive a portion of any net earnings of the corporation, and the right to
sell the stock.
Diff: 1 Type: SA Page Ref: 138
Skill: Recall
Objective List: 7.1 Illustrate how stocks are valued as the present value of dividends
Explain the Gordon growth model of stock pricing. Explain how changes in each component
affect the current stock price. On what assumptions is the model based?
Answer: The basic model is
0 =^
where
P 0 = the current stock price
D 1 = the next period's dividend
ke = the required rate of return
g = the dividend growth rate
Increases in the dividend or the dividend growth rate increase the stock price, while an increase
in the required rate of return lowers the stock price.
The two assumptions that are the basis of the model are that dividends are assumed to grow at a
constant rate, and that the dividend growth rate is less than the required rate of return.
Diff: 1 Type: SA Page Ref: 140
Skill: Recall
Objective List: 7.1 Illustrate how stocks are valued as the present value of dividends
- Describe the Price Earnings Valuation method for stocks.
Answer: Students must explain that the price earnings ration (PE) is a widely watched measure
of how much the market is willing to pay for $1 of earnings from a firm. A high PE has two
interpretations: a. The market expects earnings to rise in the future, b. The market feels that the
firm's earnings are very low risk and is therefore willing to pay a premium for them. The price to
earnings ratio is: PE =.
Diff: 2 Type: SA Page Ref: 141
Skill: Recall
Objective List: 7.1 Illustrate how stocks are valued as the present value of dividends