When determine the value of an investment, you can hire someone or analyze the risk yourself. It is very important to make sure you analyze a risk before you invest because you need to make sure there is understanding of what could happen - good and bad. The greater the risk the greater the reward, however, making sure you can afford the risk if money is lost is necessary.
C. Other things being equal, if Company A and Company B have the same firm value, Company A may have more shares of stock outstanding than Company B.
Dividend Valuation method is used to value the stock price of a company based on the dividend paid, its growth rate and rate of return. The price is calculated by calculating present value of future dividend payment.
Formula to calculate the value of stock
Price = Dividend / ( Rate or return - growth rate )
It shows that higher the rate of return lower the value of asset. more more riskier company will have higher required rate of return.
If Company A and Company B have same value and Company A have more shares than B, then Company B will have more per share value than Company A.
Analyst's estimated value per share is $2.
Enterprise value of the firm is the total value of the firm. It is used as an alternative to the market capitalization. It is the total value of equity and debts of firm.
Enterprise value = Value of equity + value of Debt
2,700,000,000 = Value of equity + $900,000,000
Value of equity = $2,700,000,000 - $900,000,000
Value of equity = $1,800,000,000
Estimated value per share = Value of equity / total number of outstanding shares
Estimated value per share = $1,800,000,000 / 900,000,000 shares
Estimated value per share = $2 per share
(A) Using the dividend valuation model, the value of company A's stock will be lower than the value of Company B’s stock
The free cash flow method of valuation uses the same discounting technique used in the dividend valuation method to arrive at the value of a company. The free cash flow method begins by discounting the free cash flow to the firm to arrive at the value of the firm, and thereafter deducts the present value of debt, to arrive at the value of equity. The dividend discount model discounts the expected dividend of the company, and includes a growth rate which accounts for the expected growth in dividend, to arrive at the value of equity. As such, if the value of company A is less than the value of company B using the free cash flow method, the same conclusion is likely to be arrived at using the dividend valuation model.
Option (B) is inaccurate because if both companies have the same firm value, then company A is more likely to have a higher debt since it has a lower equity. Note that .
Option (C) is inaccurate because we do not have sufficient information to conclude that either of the company will have more shares of stock. The question only provided for the value of the firm. We need additional information regarding the price of each stock to be able to determine which company has more shares of stock outstanding.
Option (D) is inaccurate because company B is likely to have a lower required rate of return than company A due to its higher value. This is due to the inverse relationship between value and the required rate of return. the higher the valuation of a company, the lower its required rate of return is likely to be.