Stock Valuation and Financing

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Questions and Answers

What is the primary purpose of venture capital?

To finance government projects

To provide long-term loans to established firms

To fund early-stage firms with attractive growth prospects (correct)

To acquire controlling interests in large companies

Who are venture capitalists (VCs)?

Individuals who invest their savings in start-ups

Non-profit organizations helping entrepreneurs

Government entities that support small businesses

Formal businesses that provide oversight and funding to firms (correct)

What do angel capitalists primarily provide to early-stage companies?

Equity in exchange for ownership interest (correct)

Grants with no equity stake

Structured finance products

Debt to be repaid over time

What is generally included in the agreements between venture capitalists and founders to control risks?

Covenants Signup and view all the answers

What is typically the source of initial financing for startups with high growth potential?

Private equity investors Signup and view all the answers

Which of the following is NOT an alternative for a firm wishing to sell its stock in the primary market?

Special acquisition acquisition Signup and view all the answers

Which term describes the first public issuance of a company's stock?

Initial public offering (IPO) Signup and view all the answers

What primarily influences the specific financial terms of a venture capital investment?

Factors related to founders, business structure, and perceived risk Signup and view all the answers

Which of the following best describes venture capitalists?

Private equity investors focused on startups Signup and view all the answers

What is a defined exit strategy in a venture capital context?

An agreement outlining when and how investors can exit their investment Signup and view all the answers

What role do angel capitalists play in business startups?

They are wealthy individuals investing in early-stage companies Signup and view all the answers

Which alternative is specifically highlighted as the first public sale of a firm’s stock?

Initial public offering (IPO) Signup and view all the answers

What aspect of venture capital investment is most critical for business startups?

Attractive growth prospects Signup and view all the answers

Which of the following benefits does an IPO provide to a company?

Access to new public equity capital Signup and view all the answers

What is one major difference between venture capital and angel investing?

Venture capital involves investing in early-stage startups while angel investing can involve various stages Signup and view all the answers

Why do startups often choose to go public?

To gain access to necessary funds for expansion Signup and view all the answers

What is the primary source of initial financing for most firms?

Original founders' common stock investment Signup and view all the answers

Which of the following best describes the tendency of early stage investors regarding the firm's founders?

They will invest only if the founders have a personal stake. Signup and view all the answers

What is generally the first step taken by a firm after establishing itself?

Issuing stock to a broader group Signup and view all the answers

Which of the following statements is true about cumulative preferred stock?

All passed dividends must be paid before common stock dividends. Signup and view all the answers

What is a characteristic of callable preferred stock?

The issuer can retire the shares at a specified price. Signup and view all the answers

Why are common stock investments considered essential for early stage investors?

Founders' investment indicates commitment to the business. Signup and view all the answers

What feature differentiates noncumulative preferred stock from cumulative preferred stock?

Noncumulative stock does not allow for unpaid dividends to accumulate. Signup and view all the answers

What is the primary function of private equity investors in early-stage financing?

To offer initial financing to new firms. Signup and view all the answers

Study Notes

Stock Valuation

Stock valuation is the process of determining the intrinsic value of a company's stock.
Investors use various models to estimate stock value, including those based on dividend growth, free cash flows, or other financial metrics.

Debt and Equity

Debt financing involves borrowing money, which must be repaid with interest according to a fixed schedule.
Equity financing involves providing funds to the firm, which are repaid based on the firm's performance.

Common Stock

Common stockholders are owners of the firm.
They receive what is left after all other claims are met.
They can't lose more than the amount invested.
They expect sufficient dividends and capital gains.

Preferred Stock

Preferred stockholders have higher priority over common stockholders in receiving dividends and assets.
They receive a fixed dividend.
There are two types. Par-value preferred stock uses a face value to determine the annual dividend, and no-par preferred stock uses a stated annual dividend.

Stock Issuance and Investment Bankers

Initial financing often comes from the company's founders.
Early investors often also have a stake in the company's success.
Private equity investors might contribute funds after founders have invested.
"Going public" involves selling stock to a wider investor base.
Investment bankers help companies sell stock.

Venture Capital

Venture capital is privately raised external funds for early-stage companies.
Venture capitalists (VCs) are those who provide these funds, they are typically formal businesses with oversight and pre-determined exit strategies.
Angel capitalists are wealthy individuals who invest in early-stage companies often in exchange for equity.
Venture capital investing involves specific legal contracts outlining responsibilities and ownership rights.

Going Public (IPO)

Initial Public Offerings (IPOs) are often undertaken by fast-growing companies needing more capital.
They require approval from shareholders and a financial institution (investment bank) to underwrite the IPO.
Investment banks promote and facilitate the sale of company shares.
A "Road Show" involves presentations to investors.
Underwriting syndicates spread risk among multiple banks.
Underwriters frequently discount the price offered to the company.

Stock Valuation Models

Zero-Growth Model: Stock value is the present value of a perpetual dividend.
Constant-Growth Model (Gordon-Growth Model): This estimates stock value while also taking dividend growth into consideration.
Variable-Growth Model: This model takes variable predicted growth into consideration.

Free Cash Flow Valuation Model

Free Cash Flow is used to value the entire company.
The firm's weighted average cost of capital is crucial for this model.
FCFs from different periods must be discounted back to the present value.

Other Stock Valuation Approaches

Book Value per Share: Represents the accounting value of a company's assets.
Liquidation Value per Share: Represents the current market value after considering liabilities.
Price/Earnings (P/E) Ratio Approach: Used by comparing the company's earnings per share to the average ratio of the industry.

Market Efficiency

Market Efficiency: A theoretical market where stock prices reflect all relevant information instantly and efficiently.
This often occurs in competitive markets with numerous investors.
In practice, however, there is evidence to challenge its validity.

Decision Making and Stock Value

Financial risk and return considerations should affect financial decisions.
A change in expected dividends should affect stock value.
A change in risk (measured primarily by the required return) should affect stock value.

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Description

Explore the principles of stock valuation, differentiating between debt and equity financing. This quiz covers common and preferred stock, their characteristics, and the expectations of investors. Test your knowledge of financial metrics and stockholder rights.