This document discusses stock valuation and provides examples. It begins by outlining learning goals around differentiating between debt and equity capital, understanding common and preferred stock characteristics, and using various stock valuation models. It then provides an example case study on Crocs' initial public offering in 2006, noting their growth and stock price increases. Key differences between debt and equity capital are outlined in a table, including aspects like voting rights, claims on income/assets, and tax treatment. Common and preferred stock are also differentiated in a table covering ownership, par value, voting rights, dividends and liquidation claims. An example is then shown of using the variable growth model to estimate the current value of a stock based on expected future dividend growth rates and

1. CHAPTER 7
STOCK VALUATION
Learning Goals
 Importance Of Stock Valuation
 Differentiate between debt and equity capital, discuss the rights, characteristics
features of both common and preferred stock
 Describe the process of issuing common stock, including venture capital, going
public, and the investment banker, and interpreting stock quotations
 Understand the concept of market efficiency and basic common stock valuation
using zero-growth, constant growth and variable-growth models
 Discuss the free cash flow valuation model and the book value, liquidation value,
and price / earnings (P/E) multiple approaches
 Understand the concept of market efficiency and basic common stock valuation
using zero-growth, constant-growth and variable-growth models.
 Discuss the free cash flow valuation model and the book value, liquidation value
and price earnings (P/E) multiple approaches
 Explain the relationships among financial decisions, return, risk and the firm’s
value

2. 7.1 Introduction
7.1.1 Importance of Stock Valuation For Your Life Career Development
7.1.1.1 Accounting
Firstly, in this chapter 7 (seven), a reader may understand the difference between debt
and equity in terms of tax treatment; the ownership claims of capital providers, including venture
capitalists and stockholders to emphasize why book value per share is not sophisticated basis for
common stock valuation that may interrelate the role of accounting analysis.
7.1.1.2 Information Systems
Secondly, in this chapter 7 (seven), a reader will be able to identify the procedures on
how to issue common stock through the application of information systems analysis that may
influence the prices changes.
7.1.1.3 Management
Thirdly, the reader will be understand on how to differentiate the debt and equity capital
inclusive the rights as well as the stock valuation models to propose new value for the firm’s
common stock.
7.1.1.4 Marketing
Fourthly, as a reader in this chapter also may capture on how an organization’s ideas to
embark new product and services’ ability to obtain new capital budgeting from a new project
management which emphasize the role of marketing officer assisting his or her manager.
7.1.1.5 Operations
Fifthly, in this chapter 7, a reader will be exposed on how the operation officer should be
able to think on converting their company’s asset stock or inventory whether suitable to be
recapitalized or revalued becoming a better investment for gaining more money.

3. 7.1.2 Case Study Analysis On Crosc, Inc
7.1.2.1 Initial Public Offering Specialty Analysis
One of hottest initial public offerings (IPOs) in 2006 was shoemarker Crocs. Initially
priced at $13 to $15 per share, strong demand for the stock allowed the underwriters, Piper
Jaffray and Thomas Weisel Partners, to revis the price range to $19 to $ 20. On February 7,
2006, the company went public at $21 per share, with 9.9 million shares issued in the IPO.
Crocs designs manufactures and markets a specialty line of footwear. Its brightly colored
plastic shoes are made with a proprietary “closed-cell resin material” to create pliable,
lightweight, non-making and odor-resistant shoes that mold to fit the wearer’s feet. Originally
intended as a boat in / outdoor door shoe, Crocs became fashion phenomenon selling for $30 and
$60 a pair. Crocs, Inc sells its products through its own website, traditional footwear outlets and
various specialty shops. While, at the time of the IPO, many investors were skeptical of Crocs’
ability to grow causing some shoes unable to compete duly to its limitations such as getting fade
away with cheaper imitations branding market analysis.
7.1.2.2 Calling For Investments Growth
Since the short interest the percentage of public Crocs shares that has been sold short) has
ranged from 27 percent to 40 percent. Clearly, many investors doubt the ability of the company
to continue it growth. Nearly half of the shares offered to Public sold came from insiders to cash
in on their investments and receiving nothing from the sale of those 4.5 million shares. Crocs
planned to use the remainder of the offering – funds from the sale of about 5.4 million shares to
repay debt, expand manufacturing capacity and upgrade the company’s computer systems.
However, it would have been unrewarding to bet against this stock.
7.1.2.3 Reaction Effects After IPO’s Changes
After the IPO’s price changes, most of the investors are having doubt or skeptical with
the company’s IPO ability to continue to increase its price for a better investment. However, it
would be unrewarding if the company is unable to grow. Hence, on the day, Crocs went into
public investment, its price changed and offered new opportunity to gain. Moreover, on the day

4. Crocs went public, its share price jumped from $21 to close at $28.55, a 1-day increase of nearly
36 percent. For those unable to buy the stock at its initial offering, the secondary market has
offered an opportunity to participate in further gains. As of mid-May 2007, the stock had risen to
more than $75 per share and the company announced a 2 for 1 stock split the stock had increase
to $75 per share and the company announce a 2 for 1 stock split on May 31, 2007. Finally, the
IPO is one method that normally use to raise equity capital for a company. The differences
between debt and equity capital as well as its characteristics of common and preferred stock
might have a different valuation method to be applied.
7.2 Differences Between Debt and Equity Capital
Table 7.1 : Key Differences Between Debt and Equity Capital
Type Of Capital
The long term funds of a firm inclusive items
on the right hand side of the firm’s balance
sheet excluding current liabilities
Characteristics Debt Equity
Debt capital is a long
term borrowing funds
incurred by a firm
including bonds
The log-term funds
provided by the firm’s
owners (stockholders)
Voice In Management
 Holders of common stock have voting rights
that permit them to select the firm’s directors
and to vote voting privileges only when the
firm has violated its stated contractual
obligations to them.
 Creditors (lenders), holders of equity capital
(common and preferred stockholders) are
owners of the firm.
 Holders of common stock have voting rights
that permit them to select the firm’s directors
and to vote on special issues.
 Debt holders and preferred stockholders may
No Yes

5. receive voting privileges only when the firm
has violated its stated contractual obligations to
them.
Claims On Income and Assets
 Holders of equity may have claims on income
and assets after satisfying all the distribution
payments to employees, customers,
government, creditors and equity holders.
 The claims on income and interest are
secondary matters including bank interest and
scheduled monthly principal bank loans
repayments.
 The costs of equity financing are generally
higher than debt costs. Suppliers of equity
capital will be taking more risks because of
their claims on income and assets.
 All corporations must initially be financed with
some common stock equity. Equity capital is
necessary for any company to grow.
Senior To Equity Subordinate To Debt
Maturity
 The maturity repayment is will be recognized
when the date of payment is overdue causes the
debt holders’ permanent working capital
deposit or equity capital need to be liquidated
or not becoming money to repay the overdue
monthly debt payment.
 During the bankruptcy process proceedings,
the stockholders must be able to recognize
whether the permanent equity capital can be
converted become money to avoid bankruptcy
risks
Stated None
Tax Treatment
 The interest payments to debt holders are
treated as tax deductible expenses by the
issuing firm, whereas dividend payments to a
firm’s common and preferred stockholders are
not tax deductible. The tax deductibility of
interest lowers the corporation’s cost of debt
financing to lower the cost of equity financing.
Interest deduction No deduction

6. 7.3 Common and Preferred Stock
7.3.1 Differences Of Common and Preferred Stock
Table 7.2 : Differences Of Common and Preferred Stock
Common Stock Preferred Stock
 Ownership
Privately owned (stock) by a single individual
or owned by a small group of investors such as
a family, broker or intermediary dealer in the
market who actively trading on their asset
securities exchange
 Par Value
Malaysian’s stock based on profit not using the
par value. This is a stock value that normally
occur when the firm assign its stock determined
by its common stock at a lower par value or
sold based on per share investment figure
without par value
 Preemptive Rights
The preemptive rights allows common
stockholders to maintain their proportionate
ownership in the corporation when new shares
are issued. It allows existing shareholders to
maintain voting control with dilution of
ownership rights especially whenever there is a
claim on a smaller part of the firm’s earnings.
 Authorized, Outstanding and Issued
shares
The number of shares of common stock held by
the public is categorized as an outstanding
shares. The outstanding shares are the number
of shares of common stock held by the public.
The issued shares are comprises of the number
of shares of common stock that have been put
into circulation as the sum of outstanding
shares and treasury stock. The treasury stock is
 Ownership
Preferred stock gives its holders certain
privileges that make them senior than common
stockholders’ ownership
 Par Value
Preferred stockholders are promised a fixed
periodic dividend. No par value is normally
will not indicate its dividend and use the
preference stock after the firm acquiring losses
and financing
Basic Rights
The basic rights of preferred stockholders are
more favorable than the rights of common stock
holders. Preference stock holders are having
rights on the amount claim especially during
the liquidation which is based on equal to the
par value or stated value of the preferred stock
 Restrictive Covenants
These covenants includes the sale of senior
securities, mergers, sales of assets, minimum
liquidity requirements and repurchases of
common stock. The violation of preferred stock
covenants usually permits preferred
stockholders to obtain stock at par value or
stated dividend value during making decision
of mergers, sale of assets, and repurchases of
common stock.
The cumulative preferred stock is when there is
unpaid dividends in arrears which supposed to
be paid before dividends can be paid to

7. the number of shares of outstanding stock that
have been repurchased by the firm.
 Voting Rights
Each of common stock entitles its
holder to one vote in the election.
Class A – Non-Voting Rights
Class B – Voting Rights
Treasury Stock –
Does not have
 Voting Rights
 Earn Dividends
 A Claim On Assets In
Liquidation
common stockholders.
For feature of conversion feature preferred
stock will allow holders to change each share
into a stated number of shares of common
stock.
 Common Stock Valuation
As buyer or seller must able to assess the common stock
assets’ risk and return value. The Market Efficiency is a
term that having the ability to create a new market
equilibrium price very quickly [(Scott B Smart; William
L Megginson & Lawrence J Gitman, Corporate Finance,
2nd
Edition ) (Mason, OH: South Western (2007))] .
ṝ°O = Expected benefit ($6.50) ____ = 13%
Current price of asset ($50.00)
 Preferred Stock Quotations
The financial manager needs to monitor the market
values of the firm’s outstanding stock whether it can be
trade domestically or internationally markets.
Example
Variable Growth Model
Aldern is considering to purchase a common stock from Maybank Investment. He finds that the
firm’s annual dividends payment for 2012 was RM1.50 per share. He estimates there will be
10% increase annual rate over the next 3 years (2012, 2013, 2014) after the food traditional
introduction in the business market. After 3 years maturity, the growth investment return called
as rs is at 15%. To estimate the current end of 2014 value of Maybank’s common stock PO = P2012
applies to four steps.
Step 1 : Find the Value of Cash Dividends at the end of year
Dt = Do x (1 + g1)t
= Do x FVIFg1
t
The value of dividends for 2012, 2013 and 2014 are $1.65, $ 1.82 and $2.00.``
Step 2: Find the present value of the dividends expected during the initial growth period.
Ʃ = Do X (1+g1)t
= Do X FVIFg1
t
The aum of the present value of the three dividends comprises of $4.14
Step 3 : Find the value of the stock at the end of initial growth period
[ 1 _ x D
N +1 ]
(1+ rs)N (rs - g2) = PVIFr
tN
x P N
D2013 = D2012 x (1+ 0.05) = 2.00 x 1.05 = $2.10
15% required return
5% dividend growth rate the value of the stock at the end of 2012 is calculated as follows:
P2012 – D2014 = $2.10 = $2.10 = $21.00
Rs – g2 0.13 – 0.05 0.10
PVIFrg N X PN = PVIF15%, 3 x P2014

8. = 0.658 x $21.00
= $13.82
Step 4 : Add the present value components found in steps 2 and 3 to find the value of the stock.
Po given in equation as follows:-Step 2 + Step 3
= RM4.14 + $13.82
= RM17.96 per share =
Construct the present value of stock dividends calculation table For Maybank’s Dividends
Invested by Aldern From 2012 Until 2014. Explain its relationship.
Calculation of Present Value of Maybank Dividends Investment
Made By Aldern From 2012 Until 2014
t End of year Do = D2012
(1)
FVIF 10%, t
(2)
Dt
[(1) x (2)]
(3)
PVIF 15%,
t
(4)
Present Value of
dividends
[(3) x (4)]
(5)
1 2012 $1.50 1.100 $1.65 0.870 $1.44
2 2013 $1.50 1.210 $1.82 0.756 $1.38
3 2014 $1.50 1.331 $2.00 0.658 $1.32
Sum of present value of dividends = Ʃ = Do X (1 + g)t
(1+rg)t
= $4.14
The combination calculations $4.14+$13.82 indicates that $17.96 per share estimated
carefully by using the future value percentage growth of 10% and present value of 15%. In a
stable economy ,any action of the financial manager may increase the level of expected return
without changing risk and may increase or reduce the investment share value based on the
assessment of the combined effects of return and risk on stock value also part of financial
decision making process.