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FINE 3010-01 Financial Management. Instructor: Rogério Mazali Lecture 07: 10/17/2010. FINE 3010-01 Instructor: Rogério Mazali. Fundamentals of Corporate Finance Sixth Edition Richard A. Brealey Stewart C. Myers Alan J. Marcus McGraw Hill/Irwin. Chapter 7: Valuing Stocks. Agenda.
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FINE 3010-01Financial Management Instructor: RogérioMazali Lecture 07: 10/17/2010
FINE 3010-01Instructor: RogérioMazali Fundamentals of Corporate Finance Sixth Edition Richard A. Brealey Stewart C. Myers Alan J. Marcus McGraw Hill/Irwin Chapter 7: Valuing Stocks
Agenda • Stocks and the Stock Market • Market Values, Book Values, and Liquidation Values • Valuing Common Stocks • Valuation by Comparables • Price and Intrinsic Value • The Dividend Discount Model
Stocks and the Stock Market • Q: Chapter 1: FedEx. If you want to own a part of FedEx, what should you do? • A: Buy FedEx’s common stock. • Common Stock: • A share in the firm’s future profits (dividends); • Voting rights; • In case of bankruptcy, common stockholders are the last in line. • Preferred Stock: • A share in the firm’s future profits (dividends); • No voting rights; • In case of bankruptcy, preferred stock is senior to common stock, but junior to the company’s debt.
Stocks and the Stock Market • Primary Markets: When a firm first issue stocks to the market. • First time issuing shares: Initial Public Offering (IPO). • Subsequent issues: Seasoned Equity Offering (SEO). • Auctioned by an underwriting investment bank • Secondary Markets: buying an existing share, “second-hand”, from a previous owner • Negotiated in a Stock Exchange (e.g., NYSE, AMEX, NASDAq); • Traders connected through electronic communication network
Stocks and the Stock Market • How does the Stock Exchange works? • Ms. Jones: she owns FedEx shares and would like to sell • Mr. Brown: he would like to buy FedEx shares • Each gives brokers instructions about the amount to invest (disinvest) and the price they are prepared to transact. • Ms. Jones gives her broker a market order: sell at best available price; • Mr. Brown gives his broker a limit order: buy at prices smaller than or equal to a pre-specified limit. These orders are recorded in the exchange’s limit order bookuntil they are executed.
Stocks and the Stock Market • Market Capitalization or market cap: • Price-earnings multiple or P/E ratio:
Market Values, Book Values, and Liquidation Values • How traders decide on the price to pay for stock? • Book Value = Total Assets – Liabilities • # shares outstanding: 296 million. • Book Value of Equity per share: $42.76 • Book Value ≠ Market Value
Market Values, Book Values, and Liquidation Values • Liquidation Value: value shareholders would obtain if firm sold all of its assets, paid all its debt, and distributed the rest back to shareholders • Liquidation Value does not consider intangible assets like brand value and R&D investment value • Liquidation Value ≠ Market Value
Market Values, Book Values, and Liquidation Values • Difference between Book or Liquidation Values and Market Value is often attributed to going-concern value, which refers to three factors: • Extra Earning Power • Intangible Assets • Value of Future Investments • Market Value Balance Sheet:
Valuing Common Stock • Valuation by Comparables: divide share price by measures of assets or earnings and compare against other firms in the same industry • Price-to-Book Value Ratio: • share price/Book Value per share • Price-Earnings Ratio: • Share price/Earnings per share
Price and Intrinsic Value • Chapter 6: Bonds are present value of coupons and face value • Stocks can be viewed the same way: • suppose you purchased Blue Skies, Inc. stock right after it paid dividends ; • You will hold it for one year; • Then you resell it on the market; • Payments in the period: • Dividend • Capital Gain/Loss
Price and Intrinsic Value • Remember that stock returns can be calculated as: • If we solve for , we obtain:
The Dividend Discount Model • Consider a firm with no growth opportunities • No growth => no new projects • No point in reinvesting profits • All profits will be redistributed to shareholders • Dividend per share = earnings per share
Example • What is the value of a share of a firm that is expected to pay constant dividend of $2 per share forever, starting from next year? The required rate of return is 10%
Example 2 • What is the value of a share of a firm that is not expected to grow, has 2 million shares outstanding, and had $60 million in net income last year? The required rate of return is 20%