1) For a stock to be in equilibrium, two conditions are necessary: (1) The stock’s market
price must equal its intrinsic value as seen by the marginal investor and (2) the expected
return as seen by the marginal investor must equal this investor’s required return.
2) Suppose firms follow similar financing policies, face similar risks, have equal access
to capital, and operate in competitive product and capital markets. Under these
conditions, then firms that have high profit margins will tend to have high asset
turnover ratios, and firms with low profit margins will tend to have low turnover ratios.
3) Someone who is risk averse has a general dislike for risk and a preference for
certainty. If risk aversion exists in the market, then investors in general are willing to
accept somewhat lower returns on less risky securities. Different investors have
different degrees of risk aversion, and the end result is that investors with greater risk
aversion tend to hold securities with lower risk (and therefore a lower expected return)
than investors who have more tolerance for risk.
4) The dividend irrelevance theory, proposed by Miller and Modigliani, says that
provided a firm pays at least some dividends, how much it pays does not affect either its
cost of capital or its stock price.
5) If management wants to maximize its stock price, and if it believes that the dividend
irrelevance theory is correct, then it must adhere to the residual distribution policy.
6) Any cash flows that can be classified as incremental to a particular projecti.e., results
directly from the decision to undertake the projectshould be reflected in the capital
budgeting analysis.