2. Learning Objectives:
The learners shall be able to:
A. Differentiate between debt and equity
B. Discuss the features of both common and preferred stock.
C. Describe the process of issuing common stock including venture capital, going public, and
the investment banker.
D. Understand the concept of market efficiency and basic stock valuation using zero-growth,
constant-growth, variable-growth models.
E. Discuss the free cash flow valuation model and the book value, liquidation value, and price
earnings (P/E) multiple approaches.
F. Explain the relationships among financial decisions, return, risk and the firm’s value.
3. Debt and Equity
Difference between debt and
equity.
Preference vs Ordinary
02.
Features of ordinary shares and
preference shares
Issuance of Common Stock
03.
Process of issuing common stock including
venture capital, going public, and the
investment banker
Market efficiency and basic stock
valuation using zero-growth, constant-
growth, variable-growth models.
Stock Valuation
Free cash flow valuation model and
the book value, liquidation value, and
P/E multiple approaches
Financial plan
Financial decisions, return,
risk and the firm’s value
Stock Valuation
04.
06.
05.
01.
Table of contents
7. COMPARISON
DEBT EQUITY
Definition Borrowing of money
Selling a portion in the
company
Types
Return
Loan
Interest
Stocks and shares
Dividend
Advantage
Does not give up any control
in the business.
No obligation to repay the
fund acquired
9. Preference Share
Capital
Preference Share Capital or “Preferred Stock” are usually issued @
PAR. Investors preferred to purchase preference shares because:
a. Are less risky than the ordinary shares.
b. Have a rate of return higher than ordinary shares.
c. Have a fixed rate of dividend amount and
d. Enjoy preferential rights over dividends and over
assets.
● Preference Shares Over Distribution of dividends.
● Preference over distribution of assets
11. Process of issuing common stock including venture capital, going
public, and the investment banker.
Issuance of
Common Stock
03.
12. Issuance of Common Stock
Common stock is a type of stock that is issued by a corporation to obtain funds
rather than selling debt or issuing preferred stock. Ordinary shares are what
common stocks are. When a corporation issues common stock for the first
time, it does so through an initial public offering, often known as an IPO.
13. Steps a company must undertake to go public
via an IPO process:
16. Market efficiency refers to the
degree to which market prices
reflect all available, relevant
information. If markets are efficient,
then all information is already
incorporated into prices, and so
there is no way to "beat" the market
because there are no undervalued or
overvalued securities available.
This means that we cannot
determine which stocks are “good”
and which are “bad”. All stocks are
properly valued given what is known
today. If they turn out to be “good” or
“bad” in the future, it is due to
information that has yet to be
revealed.
17. BASIC STOCK VALUATION
Stock valuation based on the dividend discount
model typically takes one of three forms depending on
what pattern we expect the dividends to follow. These
three model variations are (1) the zero growth model, (2)
the constant-growth model, and (3) the variable-growth
model.
18. ZERO-GROWTH MODEL
According to the no-growth model, to find the value of the stock, we just take the
current dividend and divide by the required return (remember, it’s just a perpetuity — an
infinite annuity — since the stock has no maturity date and the dividend is not expected to
increase or decrease in value). This is written below
where
P0 represents the current value (price today)
k represents the required return and
D1 represents the dividend
19. ZERO-GROWTH MODEL
Consider the following example with a preferred stock. Assuming that a
preferred stock has a par value of $75, pays a 10% dividend and you have an 8%
required return, what is this stock worth to you?
20. CONSTANT-GROWTH MODEL
The constant growth model is a widely cited dividend valuation approach that
assumes that dividends will grow at a constant rate, but a rate that is less than the
required return.
where
g is the growth rate in dividends
P0 represents the current value (price today)
k represent the required return and
D0 and D1 represent the dividend paid today (D0) or the forecasted dividend next year (D1) respectively
OR
21. CONSTANT-GROWTH MODEL
For a quick example, consider
a stock that just paid a dividend
(D0) of $5.00 per share with
dividends growing at a constant
4% per year. If my required return is
13%, what is the stock worth to
me?
22. VARIABLE-GROWTH MODEL
The variable growth model is a dividend valuation approach that allows for a change in the
dividend growth rate. To determine the value of a share of stock in the case of variable growth, we
use a three-step procedure.
Step 1 – Forecast the dividends during the non-constant growth period up to the
first year at which dividends grow at a constant rate.
Step 2 – Once a constant growth rate is reached, use the constant growth pricing
model to forecast the stock price. This stock price represents the PV of all
dividends beyond the non-constant growth period.
Step 3 – Discount the cash flows (dividends found in step one and price found in
step two) back to year zero at the appropriate discount rate. This is the current
value of the stock.
23. FREE CASH FLOW VALUATION MODEL AND THE BOOK VALUE, LIQUIDATION
VALUE, AND PRICE EARNINGS (P/E) MULTIPLE APPROACHES
Stock Valuation
05.
24. Stock Valuation
Stock value is a part of
a service rendered to
an entity called
Fairness Opinion or
Valuation Services.
Investors are at
advantage if it would
be able to estimate
properly a stock’s
intrinsic (or “true”)
value.
THE PROCESS OF DETERMINING A
STOCK’S VALUE
25. Stock Valuation
Sell/Do not acquire
Intrinsic value
<
Stock Price (Traded Price)
“overvalued”
Buy/Acquire
Intrinsic value
>
Stock Price (Traded Price)
“undervalued”
26. DISCOUNTED
DIVIDEND MODEL
STOCK VALUATION
Methods of Stock Valuation
FREE CASH FLOW
VALUATION MODEL
BOOK VALUE
APPROACH
DISCOUNTED
TECHNIQUES
NON-DISCOUNTED
TECHNIQUES
- Zero-Growth Model
- Constant-Growth Model
- Variable-Growth Model
LIQUIDATION VALUE
APPROACH
PRICE/EARNINGS
MULTIPLE APPROACH
27. ● A model that determines the value of an entire company as the present
value of its expected free cash flows discounted at the firm’s weighted average
cost of capital (WACC), which is its expected average future cost of funds over
the long run.
● The discounting concepts are very similar to that of the discounted
dividend model, however with some new elements:
Po = stock price today
MVfirm = market value of the firm
MVdebt + preferred = market value of debt and preferred
FCF = free cash flow at the end of year 1
WACC = weighted average cost of capital
g = growth rate
OCS = outstanding common shares
Free Cash Flow Valuation Model
28. Free Cash Flow Valuation Model
Stock Value (Po):
● The market value of the firm less the market value of debt and preferred
shares represent the remainder of the firm’s market value that is available
to common or ordinary shareholders.
Stock Value Firm’s Market Value Free Cash Flow
29. Free Cash Flow Valuation Model
Zero-Growth Firms Constant- Growth Firms
Var iable-
Growth Firms
Firm’s Market Value (MV firm):
30. Free Cash Flow Valuation Model
Free Cash Flow (FCF):
● The free cash flow is the cash generated before any payment is made to the
investors. Free cash flow originally comes from the computation of the net
income but distinctly modified to reflected the actual cash flows of the firm.
31. Free Cash Flow Valuation Model
Example Problem:
8479 Corporation has projected Earnings Before Interest and Tax (EBIT) for the
next year of P600 million, with tax rate of 40%, projected depreciation expense,
capital expenditures and increase in working capital for the next year of P100
million, P200 million and P120 million, respectively. The capital structure of the
company is 40% debt and 60% equity. Its WACC is 10%. The company’s free cash
flow is expected to grow at a constant rate of 6 percent a year. The firm has P500
million in debt and preferred shares with P20 million preferred shares
outstanding and 300 million ordinary shares outstanding. Determine 8479’s
stock price.
37. ● The valuation of stocks may involve a computation, summarily, based on
financial statements and fundamental information.
● This method of stock valuation takes into consideration the financial
performance of the company or the current book value of its shareholders’
equity.
● These techniques utilize market information and employ the market
information to the net income of the firm being valued.
● The more popular approaches include:
○ book value approach;
○ liquidation value approach; and
○ price/earnings multiple approach.
Non-Discounted Techniques
38. Book Value or Net Asset Value Approach
Book Value per share
● The amount per share of common stock that would be received if all of the
firm’s assets were sold for their exact book (accounting) value and the
proceeds remaining after paying all the liabilities (including preferred
stock) were divided among the common stockholders.
39. Book Value or Net Asset Value Approach
Example Problem
SEC Company has the following information derived from its most recent audited
financial statements:
● Total Assets = P20,000,000,000
● Total Liabilities = P10,000,000,000
● Total Shareholders’ Equity = P10,000,000,000
● No. of ordinary shares issued and outstanding = 1,000,000,000 shares
Determine the NAVPS or BVPS.
41. Book Value or Net Asset Value Approach
Example Problem
If the company had another class of stock such as preferred shares amounting to
600,000,000 shares with a total equity of P2,500,000,000, then what would be
the NAVPS or BVPS?
42. Book Value or Net Asset Value Approach
Example Problem
At year-end 2020, Lamar Company’s balance sheet shows total assets P6 million,
total liabilities and preferred stock of P4.5 million, and 100,000 shares of
common stock outstanding. What would be the book value per share?
43. Liquidation Value Approach
Liquidation value per share
● The actual amount per share of common stock that would be received if all of
the firm’s assets were sold for their market value, liabilities (including
preferred stock) were paid, and any remaining money were divided among
the common stockholders.
44. Liquidation Value Approach
Example Problem
Lamar Company found on investigation that it could obtain only P5.25 million if
it sold its assets today. What would be the firm’s liquidation value per share?
45. Price/Earnings (P/E) Multiples
Price/Earnings Multiple Approach
● A popular technique used to estimate the firm’s share value; calculated by
multiplying the firm’s expected earnings per share (EPS) by the average
price/earnings (P/E) ratio for the industry.
46. Price/Earnings (P/E) Multiples
Example Problem
Ann Perrier plans to use the price/earnings multiple approach to estimate the
value of Lamar Company’s stock, which she currently holds in her retirement
account. She estimates that Lamar Company will earn P2.60 per share next year
(2023). This expectation is based on an analysis of the firm’s historical earnings
trend and of expected economic and industry conditions. She finds the
price/earnings (P/E) ratio for firms in the same industry to average 7.
47. Price/Earnings (P/E) Multiples
Example Problem
NA Technologies, Inc. has a net income of P1 billion reported on the previous
year’s audited financial statements. In the same period, the company has 1
billion in shares issued and outstanding. NA Technologies is currently operating
in the computer and gadgets industry. Information has been gathered that the
prevailing P/E Ratio (price-earnings ratio) in the computer industry is 5x.
Determine the value of the stock.
50. Risk and Return
Risk
The term risk refers to
the possibility of
occurring something
unpleasant, undesirable
or unwelcome
It creates both problems
and opportunities for
business and
individuals.
Risk regarding the
possibility of loss can
be especially
problematic.
52. On the basis of Occurrence:
Pure Risks
when there is uncertainty
as to whether loss will
occur or not
Examples are: fire,
illness, job-related
accidents
Speculative Risks
when there is uncertainty
about an event that could
produce either profit or
loss.
Example: Business or
investment trading risks
53. On the basis of Flexibility:
Static Risks
Remains indifferent in
changing economic-
environment.
Example: risk of
dishonesty of employees
Dynamic Risks
those resulting from
changes in the economy.
Example: technological
changes may cause loss
to the business
enterprise
54. On the basis of Measurement:
Financial
Risks
refers to uncertainty
which can be measured
in terms of money.
3 Features of Financial
Risks (1) Adversity, (2)
financial loss and (3)
direct relationship
between peril and cause
of loss.
Non-Financial
Risks
the risks which cannot be
measured in money
terms
55. On the basis of Coverage:
Fundamental
Risks
are those risks which
tend to affect a large
section of society, the
entire economy, and a
large number of persons,
rather than individuals
Particular
Risks
Has restricted impact.
56. On the basis of Behaviour:
Subjective
Risks
psychological uncertainty
based on a person’s
mental ability especially
perceiving different
outcomes of identical
situations.
Objective
Risks
is more precise,
observable, and thus
measurable. In general,
objective risk is the
possible variation of
actual from expected
experience
57. On the basis of Diversification:
Diversified
Risks
Unsystematic risks are,
generally, indicated by
leverages of a firm.
Unsystematic risk
includes the following
types of risk: (a) Business
risk, and (b) Financial
risk.
Non-Diversified
Risks
mitigated only by means
of hedging. Systematic
risk underlies all other
investment
risks.Systematic risk
includes: (a) market risk,
(b) interest rate risk, (c)
inflation rate risk
(purchasing power risk).
58. Risk and Return
Return
the motivating force and
the principal reward in
the investment.
prime objective of
making investment in
any security
provides a basis of
comparison among
given alternative
investment
opportunities.
60. Two Types of Returns:
Realized
Return
is the actual outcome on
investment
Expected
Return
the probable return on
investment over the
future period
61. Firms Value
It is an economic concept
that reflects the value of a
business.
It is an amount that one
needs to pay to buy/take
over a business entity.
64. CREDITS: This presentation template was created by
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Group 5
CALMA, Janelle G
MARASIGAN, Ma. Arwen Cassandra V.
MORALES, Mary Rose M.
PEREZ, Champ S.
PUNO, Trixx Angeline L.
