Textbook Notes (368,288)
Canada (161,770)
Finance (37)
MGFB10H3 (19)
Derek Chau (11)
Chapter 7

Chapter 7 Notes

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Derek Chau

Chapter 7 Equity Valuation Notes 7.1 Equity Securities equity securities ownership interests in an underlying entity, usually a corporation equities pay dividends from after-tax earnings, unlike interest payments, they dont provide issuer with tax-deductible expense however, shareholders pay lower taxes on dividends received from Canadian corporations than they would on interest payments common share a certificate of ownership in a corporation; the most common type of equity security common shareholders represent the true owners of the corporation, and are the residual claimants of the corporation, which means that they are entitled to income remaining only after all creditors and preferred shareholders have been paid preferred share the other major type of equity security, which gives the owner a claim to a fixed dividend rate that is established when the shares are first issued; rarely have any voting rights traditionally, preferred shares had no maturity date, but over the past 30 years they have been increasingly issued with a fixed maturity date, similar to a bond; however, unlike bonds, dividends are not a legal obligation until that declaration is made Valuation of Equity Securities a commonly used method follows the discounted cash flow approach used to estimate the value of bonds the discount rate for equities will equal the risk-free rate of return plus a risk premiumk = RF + Risk Premium the risk premium will be based on an estimate of the risk associated with the security; the higher the risk, the higher the risk premium, because investors will require a higher return as compensation in addition to discount rate, investors must estimate size and timing of the expected cash flows associated with an equity security 7.2 Preferred Share Valuation because payments are essentially fixed when preferred shares are issued, such shares are referred to as fixed income investments Pps D pk p where P ps the market price, Dpis the dividend amount, and kpis the discount rate the amount of the dividend payments is usually based on stated par (or face) value and a stated dividend rate preferred shares will trade at par when the dividend rate equals the market rate, at a discount from par when market rates exceed the dividend rate, and at a premium when market rates are less than the dividend rate the market prices of preferred
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