Stock valuation33

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Stock valuation33

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Stock valuation33

  1. 1. Chapter 8 - Stock Valuation  2005, Pearson Prentice Hall
  2. 2. Security Valuation <ul><li>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 . </li></ul>
  3. 3. Preferred Stock <ul><li>A hybrid security : </li></ul><ul><li>It’s like common stock - no fixed maturity. </li></ul>
  4. 4. Preferred Stock <ul><li>A hybrid security : </li></ul><ul><li>It’s like common stock - no fixed maturity. </li></ul><ul><ul><li>Technically, it’s part of equity capital . </li></ul></ul>
  5. 5. Preferred Stock <ul><li>A hybrid security : </li></ul><ul><li>It’s like common stock - no fixed maturity. </li></ul><ul><ul><li>Technically, it’s part of equity capital. </li></ul></ul><ul><li>It’s like debt - preferred dividends are fixed. </li></ul>
  6. 6. Preferred Stock <ul><li>A hybrid security : </li></ul><ul><li>It’s like common stock - no fixed maturity. </li></ul><ul><ul><li>Technically, it’s part of equity capital. </li></ul></ul><ul><li>It’s like debt - preferred dividends are fixed. </li></ul><ul><ul><li>Missing a preferred dividend does not constitute default, but preferred dividends are cumulative . </li></ul></ul>
  7. 7. <ul><li>Usually sold for $25, $50, or $100 per share. </li></ul><ul><li>Dividends are fixed either as a dollar amount or as a percentage of par value. </li></ul><ul><li>Example: In 1988, Xerox issued $75 million of 8.25% preferred stock at $50 per share. </li></ul><ul><ul><li>$4.125 is the fixed, annual dividend per share. </li></ul></ul>Preferred Stock
  8. 8. <ul><li>Firms may have multiple classes of preferreds, each with different features. </li></ul><ul><li>Priority : lower than debt, higher than common stock. </li></ul><ul><li>Cumulative feature : all past unpaid preferred stock dividends must be paid before any common stock dividends are declared. </li></ul>Preferred Stock Features
  9. 9. <ul><li>Protective provisions are common . </li></ul><ul><li>Convertibility : many preferreds are convertible into common shares. </li></ul><ul><li>Adjustable rate preferreds have dividends tied to interest rates. </li></ul><ul><li>Participation : some (very few) preferreds have dividends tied to the firm’s earnings. </li></ul>Preferred Stock Features
  10. 10. <ul><li>PIK Preferred : Pay-in-kind preferred stocks pay additional preferred shares to investors rather than cash dividends. </li></ul><ul><li>Retirement : Most preferreds are callable, and many include a sinking fund provision to set cash aside for the purpose of retiring preferred shares. </li></ul>Preferred Stock Features
  11. 11. Preferred Stock Valuation <ul><li>A preferred stock can usually be valued like a perpetuity: </li></ul>
  12. 12. Preferred Stock Valuation <ul><li>A preferred stock can usually be valued like a perpetuity: </li></ul>V = D k ps ps
  13. 13. Example: <ul><li>Xerox preferred pays an 8.25% dividend on a $50 par value. </li></ul><ul><li>Suppose our required rate of return on Xerox preferred is 9.5% . </li></ul>
  14. 14. Example: <ul><li>Xerox preferred pays an 8.25% dividend on a $50 par value. </li></ul><ul><li>Suppose our required rate of return on Xerox preferred is 9.5% . </li></ul>V ps = 4.125 .095 =
  15. 15. Example: <ul><li>Xerox preferred pays an 8.25% dividend on a $50 par value. </li></ul><ul><li>Suppose our required rate of return on Xerox preferred is 9.5% . </li></ul>V ps = 4.125 .095 = $43.42
  16. 16. Expected Rate of Return on Preferred <ul><li>Just adjust the valuation model: </li></ul>
  17. 17. Expected Rate of Return on Preferred <ul><li>Just adjust the valuation model: </li></ul>D P o k ps =
  18. 18. Example <ul><li>If we know the preferred stock price is $40 , and the preferred dividend is $4.125 , the expected return is: </li></ul>
  19. 19. Example <ul><li>If we know the preferred stock price is $40 , and the preferred dividend is $4.125 , the expected return is: </li></ul>D P o k ps = = = 4.125 40
  20. 20. Example <ul><li>If we know the preferred stock price is $40 , and the preferred dividend is $4.125 , the expected return is: </li></ul>D P o k ps = = = .1031 4.125 40
  21. 21. The Financial Pages: Preferred Stocks <ul><li>52 weeks Yld Vol </li></ul><ul><li>Hi Lo Sym Div % PE 100s Close </li></ul><ul><li>27 88 25 06 GenMotor pfG 2.28 8.9 … 86 25 53 </li></ul><ul><li>Dividend: $2.28 on $25 par value </li></ul><ul><li>= 9.12% dividend rate. </li></ul><ul><li>Expected return: 2.28 / 25.53 = 8.9%. </li></ul>
  22. 22. Common Stock <ul><li>Is a variable-income security. </li></ul><ul><ul><li>Dividends may be increased or decreased, depending on earnings. </li></ul></ul><ul><li>Represents equity or ownership. </li></ul><ul><li>Includes voting rights . </li></ul><ul><li>Limited liability : liability is limited to amount of owners’ investment. </li></ul><ul><li>Priority : lower than debt and preferred. </li></ul>
  23. 23. Common Stock Characteristics <ul><li>Claim on Income - a stockholder has a claim on the firm’s residual income. </li></ul><ul><li>Claim on Assets - a stockholder has a residual claim on the firm’s assets in case of liquidation. </li></ul><ul><li>Preemptive Rights - stockholders may share proportionally in any new stock issues. </li></ul><ul><li>Voting Rights - right to vote for the firm’s board of directors. </li></ul>
  24. 24. <ul><li>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. </li></ul><ul><li>If you require a 15% rate of return, what would you pay for the stock now? </li></ul>Common Stock Valuation (Single Holding Period)
  25. 25. <ul><li>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. </li></ul><ul><li>If you require a 15% rate of return, what would you pay for the stock now? </li></ul>Common Stock Valuation (Single Holding Period) 0 1 ? 5.50 + 120
  26. 26. Common Stock Valuation (Single Holding Period) <ul><li>Solution: </li></ul><ul><li>Vcs = (5.50/1.15) + (120/1.15) </li></ul><ul><li>= 4.783 + 104.348 </li></ul><ul><li>= $109.13 </li></ul>
  27. 27. Common Stock Valuation (Single Holding Period) <ul><li>Financial Calculator solution: </li></ul><ul><li>P/Y =1, I = 15, n=1, FV= 125.50 </li></ul><ul><li>solve: PV = -109.13 </li></ul><ul><li>or: </li></ul><ul><li>P/Y =1, I = 15, n=1, FV= 120, </li></ul><ul><li>PMT = 5.50 </li></ul><ul><li>solve: PV = -109.13 </li></ul>
  28. 28. The Financial Pages: Common Stocks <ul><li>52 weeks Yld Vol Net </li></ul><ul><li>Hi Lo Sym Div % PE 100s Hi Lo Close Chg </li></ul><ul><li>135 80 IBM .52 .5 21 142349 99 93 94 96 -3 43 </li></ul><ul><li>82 18 CiscoSys … 47 1189057 21 19 20 25 -1 13 </li></ul>
  29. 29. Common Stock Valuation (Multiple Holding Periods) <ul><li>Constant Growth Model </li></ul><ul><li>Assumes common stock dividends will grow at a constant rate into the future. </li></ul>
  30. 30. Common Stock Valuation (Multiple Holding Periods) <ul><li>Constant Growth Model </li></ul><ul><li>Assumes common stock dividends will grow at a constant rate into the future. </li></ul>V cs = D 1 k cs - g
  31. 31. <ul><li>Constant Growth Model </li></ul><ul><li>Assumes common stock dividends will grow at a constant rate into the future. </li></ul>
  32. 32. <ul><li>Constant Growth Model </li></ul><ul><li>Assumes common stock dividends will grow at a constant rate into the future. </li></ul>V cs = D 1 k cs - g
  33. 33. <ul><li>Constant Growth Model </li></ul><ul><li>Assumes common stock dividends will grow at a constant rate into the future. </li></ul><ul><li>D 1 = the dividend at the end of period 1. </li></ul><ul><li>k cs = the required return on the common stock. </li></ul><ul><li>g = the constant, annual dividend growth rate. </li></ul>V cs = D 1 k cs - g
  34. 34. Example <ul><li>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% ? </li></ul>
  35. 35. Example <ul><li>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% ? </li></ul>D 0 = $5, so D 1 = 5 (1.10) = $5.50
  36. 36. Example <ul><li>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% ? </li></ul>V cs =
  37. 37. Example <ul><li>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% ? </li></ul>V cs = = D 1 k cs - g
  38. 38. Example <ul><li>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% ? </li></ul>V cs = = = D 1 5.50 k cs - g .15 - .10
  39. 39. Example <ul><li>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% ? </li></ul>V cs = = = $110 D 1 5.50 k cs - g .15 - .10
  40. 40. Expected Return on Common Stock <ul><li>Just adjust the valuation model </li></ul>
  41. 41. Expected Return on Common Stock <ul><li>Just adjust the valuation model </li></ul>V cs = D k cs - g
  42. 42. Expected Return on Common Stock <ul><li>Just adjust the valuation model </li></ul>V cs = D k cs - g k = ( ) + g D 1 V cs
  43. 43. Expected Return on Common Stock <ul><li>Just adjust the valuation model </li></ul>V cs = D k cs - g k = ( ) + g D 1 P o
  44. 44. Example <ul><li>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% . </li></ul>
  45. 45. Example <ul><li>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% . </li></ul>k cs = ( ) + g D 1 P o
  46. 46. Example <ul><li>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% . </li></ul>k cs = ( ) + g D 1 P o k cs = ( ) + .05 = 3.00 27
  47. 47. Example <ul><li>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% . </li></ul>k cs = ( ) + g D 1 P o k cs = ( ) + .05 = 16.11% 3.00 27

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