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Chapter 8

Chapter 8. Valuation and Characteristics of Stock. Security Valuation. In general, the intrinsic value of an asset = the present value of the stream of expected cash flows discounted at an appropriate required rate of return. Preferred Stock.

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Chapter 8

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  1. Chapter 8

  2. Valuation and Characteristics of Stock

  3. Security Valuation • In general, the intrinsic value of an asset = the present value of the stream of expected cash flows discounted at an appropriate required rate of return.

  4. Preferred Stock A hybrid security: • it’s like common stock - no fixed maturity. • technically, it’s part of equity capital. • it’s like debt - preferred dividends are fixed. • missing a preferred dividend does not constitute default, but preferred dividends are cumulative.

  5. Preferred Stock • Usually sold for $25, $50, or $100 per share. • Dividends are often quoted as a percentage of par.

  6. Preferred Stock • Usually sold for $25, $50, or $100 per share. • Dividends are often quoted as a percentage of par. • Example: In 1988, Xerox issued $75 million of 8.25% preferred stock at $50 per share.

  7. Preferred Stock • Usually sold for $25, $50, or $100 per share. • Dividends are often quoted as a percentage of par. • Example: In 1988, Xerox issued $75 million of 8.25% preferred stock at $50 per share. • $4.125 is the fixed, annual dividend per share.

  8. Preferred Stock • May be callable and convertible. • Is usually non-voting. • Priority: lower than debt, higher than common stock. • Usually includes protective provisions. • May include a sinking fund provision.

  9. D V = ps k ps Preferred Stock Valuation • A preferred stock can usually be valued like a perpetuity:

  10. Example: • Xerox preferred pays an 8.25% dividend on a $50 par value. • Suppose our required rate of return on Xerox preferred is 9.5%.

  11. 4.125 V = = ps .095 Example: • Xerox preferred pays an 8.25% dividend on a $50 par value. • Suppose our required rate of return on Xerox preferred is 9.5%.

  12. 4.125 V = = $43.42 ps .095 Example: • Xerox preferred pays an 8.25% dividend on a $50 par value. • Suppose our required rate of return on Xerox preferred is 9.5%.

  13. Expected Rate of Return on Preferred • Just adjust the valuation model:

  14. D Po kps = Expected Rate of Return on Preferred • Just adjust the valuation model:

  15. Example • If we know the preferred stock price is $40, and the preferred dividend is $4.125, the expected return is:

  16. D Po 4.125 40 kps = = = Example • If we know the preferred stock price is $40, and the preferred dividend is $4.125, the expected return is:

  17. D Po 4.125 40 kps = = = .1031 Example • If we know the preferred stock price is $40, and the preferred dividend is $4.125, the expected return is:

  18. The Financial Pages:Preferred Stocks 52 weeks Yld Vol Hi Lo Sym Div % PE 100s Close 293/8 251/8 GenMotor pfG 2.28 8.8 … 27 25 7/8 • Dividend: $2.28 on $25 par value = 9.12% dividend rate. • Expected return: 2.28 / 25.875 = 8.8%.

  19. Common Stock • is a variable-income security. • dividends may be increased or decreased, depending on earnings. • represents equity or ownership. • includes voting rights. • Priority: lower than debt and preferred.

  20. Common Stock Characteristics • Claim on Income - a stockholder has a claim on the firm’s residual income. • Claim on Assets - a stockholder has a residual claim on the firm’s assets in case of liquidation. • Preemptive Rights - stockholders may share proportionally in any new stock issues. • Voting Rights - right to vote for the firm’s board of directors.

  21. Common Stock Valuation(Single Holding Period) • You expect XYZ stock to pay a $5.50 dividend at the end of the year. The stock price is expected to be $120 at that time. • If you require a 15% rate of return, what would you pay for the stock now?

  22. ? 5.50 + 120 0 1 Common Stock Valuation(Single Holding Period) • You expect XYZ stock to pay a $5.50 dividend at the end of the year. The stock price is expected to be $120 at that time. • If you require a 15% rate of return, what would you pay for the stock now?

  23. Common Stock Valuation(Single Holding Period) Financial Calculator solution: P/Y =1, I = 15, n=1, FV= 125.50 solve: PV = -109.13 or: P/Y =1, I = 15, n=1, FV= 120, PMT = 5.50 solve: PV = -109.13

  24. The Financial Pages:Common Stocks 52 weeks Yld Vol Net Hi Lo Sym Div % PE 100s Hi Lo Close Chg 139 81 IBM .48 .5 26 56598 108 106 1065/8 -2 119 75 MSFT … 60 254888 96 93 953/8 +1/4

  25. Common Stock Valuation(Multiple Holding Periods) • Constant Growth Model • Assumes common stock dividends will grow at a constant rate into the future.

  26. D1 kcs - g Vcs = Common Stock Valuation(Multiple Holding Periods) • Constant Growth Model • Assumes common stock dividends will grow at a constant rate into the future.

  27. Constant Growth Model • Assumes common stock dividends will grow at a constant rate into the future.

  28. D1 kcs - g Vcs = • Constant Growth Model • Assumes common stock dividends will grow at a constant rate into the future.

  29. D1 kcs - g Vcs = • Constant Growth Model • Assumes common stock dividends will grow at a constant rate into the future. • D1 = the dividend at the end of period 1. • kcs= the required return on the common stock. • g = the constant, annual dividend growth rate.

  30. Example • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%?

  31. Example • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%? D0 = $5, so D1 = 5 (1.10) = $5.50

  32. Vcs = Example • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%?

  33. D1 kcs - g Vcs = = Example • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%?

  34. D15.50 kcs - g .15 - .10 Vcs = = = Example • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%?

  35. D1 5.50 kcs - g .15 - .10 Vcs = = = $110 Example • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%?

  36. Expected Return on Common Stock • Just adjust the valuation model

  37. D kcs - g Vcs = Expected Return on Common Stock • Just adjust the valuation model

  38. D kcs - g Vcs = D1 Vcs k = ( ) + g Expected Return on Common Stock • Just adjust the valuation model

  39. D kcs - g Vcs = D1 Po k = ( ) + g Expected Return on Common Stock • Just adjust the valuation model

  40. Example • We know a stock will pay a $3.00 dividend at time 1, has a price of $27 and an expected growth rate of 5%.

  41. D1 Po kcs = ( ) + g Example • We know a stock will pay a $3.00 dividend at time 1, has a price of $27 and an expected growth rate of 5%.

  42. D1 Po kcs = ( ) + g kcs = ( ) + .05 = 3.00 27 Example • We know a stock will pay a $3.00 dividend at time 1, has a price of $27 and an expected growth rate of 5%.

  43. D1 Po kcs = ( ) + g kcs = ( ) + .05 = 16.11% 3.00 27 Example • We know a stock will pay a $3.00 dividend at time 1, has a price of $27 and an expected growth rate of 5%.

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