Chapter 7
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Chapter 7 Presentation Transcript

  • 1. Chapter 7 Stock Valuation
    • Common Stock Basics
    • Stock Valuation – Future Cash Flows
    • Dividend Pricing Models
    • Dividend Growth Models
    • Changing Dividend Patterns
    • Preferred Stock
    • CAPM
    • Beta
    • Common Stock Features
  • 2. Common Stock Basics
    • Common Stock – Ownership of Company
      • Equity financing
      • Major financing source for companies
    • Voting Rights
      • Pick the management team of the company
      • Determine charter and changes to charter
    • Receive Dividends
      • Payment of “profits”
      • Principal not repaid until shareholder sells stock
  • 3. Stock Valuation
    • Just like a bond…the value is all future cash flows received
    • Final payment (when stock is sold) is the same as principal repayment
    • Dividends are the same as coupons
  • 4. Dividend Pricing Models
    • Four Models
      • Two assumptions
        • Growth, constant or no-growth dividend or dividend growing at a constant rate
        • Horizon, finite or infinite
    • Constant Dividend and Infinite Horizon
      • Priced as a perpetuity
      • Price = Dividend / r
      • r is the desired rate of return on investment
  • 5. Dividend Pricing Models
    • Constant Dividend with Finite Horizon
      • Assumption on final payment
        • Dividends Only – Only annuity stream formula
        • Dividends and Final Sale at end of horizon – Annuity Stream and Lump Sum formula
      • TVM equations
    • Finding Bond Selling Price
      • New owner buys remaining dividend stream
      • Perpetuity for new owner?
  • 6. Dividend Growth Models
    • Common practice to raise dividends each year
      • Example, Coca-Cola
      • Dividend changes range
        • $0.04 to $0.08
        • 5.88% to 14.71%
      • Not constant…but…
      • Smooth out pattern for constant percentage change each year
    • Constant percentage change allows for a simplified pricing model
  • 7. Dividend Growth Models
    • First Constant Growth Model – Infinite Horizon
      • Need g, the dividend growth rate
      • Need r, the require rate of return
      • Both stated on annual basis
  • 8. Dividend Growth Models
    • Finding g,
      • Averaging annual dividend changes
      • g = (Last Dividend / First Dividend) 1/n
        • n is the number of dividend changes
        • Example of Johnson and Johnson, g = 13.8%
    • Select r, example J&J, r = 15%
  • 9. Dividend Growth Models
    • Adjusted for Finite Horizon
      • Dividend stream for a fixed period of time but still has constant growth, g>0
      • Shareholder only gets a portion of infinite dividend stream
    • Add portion adjustment to model
  • 10. Changing Dividend Patterns
    • What happens when g is not constant or the dividends are not constant?
    • Look for patterns inside the overall dividend stream
      • Series of dividends with constant dividends
      • Series of dividends with constant growth
    • Apply models within the series finding PV of the series
    • Add up all present value pieces for price
  • 11. Preferred Stock
    • Preferred stock has stated annual dividend
      • Constant dividend each period
      • Dividend = dividend rate x par value
    • Preferred stock has no maturity date
      • Infinite horizon
      • No payment of par value
    • Fits constant dividend model with infinite horizon
  • 12. CAPM
    • Capital Asset Pricing Model – CAPM
    • Future cash flows (dividends)
      • Difficult to predict
      • May not follow nice patterns
    • More encompassing model
    • CAPM – Expected return is directly related to risk (Chapter 5, Risk and Return)
    • Model works with returns
  • 13. CAPM
    • Assumptions
      • #1 – There is a reward for waiting
      • #2 – The greater the risk the greater the expected reward
      • #3 – There is a constant tradeoff between risk and reward
    • E(return) = risk-free rate + slope (level of risk)
    • Trick is to find the level of risk for an investment
  • 14. Beta
    • Beta – A measure of risk
      • The systematic risk of an individual asset in a well-diversified portfolio
      • Correlation between an asset’s returns and the market in general
      • Estimated with OLS regression
    • Beta’s
      • Less than 1, 1 or greater than 1
      • Less risk than market, same risk as market, greater risk than the market
  • 15. Beta
    • Using Beta
      • Security Market Line
      • All firms plot on SML (ex-ante)
        • Firms above the line are under priced
        • Firms below the line are over priced
    • Security Market Line estimates expected returns
  • 16. Common Stock Features
    • Claim on Assets and Cash Flows (Residual)
    • No Maturity Date
    • Vote (Voice in Management)
    • Tax Issues – Dividends Taxable
    • Other Issues
      • Authorized, Outstanding, Treasury Shares
      • Pre-emptive Rights
  • 17. Problems
    • Problem 1 – Constant Dividend, Infinite Horizon
    • Problem 2 – Constant Dividend, Infinite Horizon
    • Problem 3 – Constant Dividend, Infinite Horizon
    • Problem 5 – Constant Growth, Infinite Horizon
    • Problem 7 – Constant Growth, Finite Horizon
    • Problem 11 – Preferred Stock
    • Problem 15 – Security Market Line
    • Problem 17 – Expected Returns