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!toc"s and #heir$aluation
Features of Common Stock
Determining Common Stock
ValuesPreferred Stock
Chapter 9
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Facts about Common Stock
Represents ownership
wnership implies control
Stockholders elect directors
Directors elect management
!anagement"s goal# !a$imi%e the stockprice
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'ntrinsic Value and Stock Price
utside in(estors) corporate insiders) andanal*sts use a (ariet* of approaches toestimate a stock"s intrinsic (alue +P,.
'n e/uilibrium we assume that a stock"sprice e/uals its intrinsic (alue.
utsiders estimate intrinsic (alue to helpdetermine which stocks are attracti(e tobu* and0or sell.
Stocks with a price below +abo(e itsintrinsic (alue are under(alued+o(er(alued.
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Determinants of 'ntrinsic Value andStock Prices
23rue4Risk
2Percei(ed4
'n(estor CashFlows
2Percei(ed4Risk
!anagerial 5ctions) the 6conomic6n(ironment) 3a$es) and the Political
Climate
Stock"s'ntrinsic
Value
Stock"s!arket Price
!arket 6/uilibrium#'ntrinsic Value 7 Stock
Price
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Dierent 5pproaches for 6stimatingthe 'ntrinsic Value of a Common Stock
Discounted di(idend model
Corporate (aluation model
P06 multiple approach
6V5 approach
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Discounted Di(idend !odel
Value of a stock is the present (alue ofthe future di(idends e$pected to begenerated b* the stock.
+
++
+
+
+
+
+
=
r+1D...
r+1D
r+1D
r+1DP;
s
s
&
s
&1
s
1,
9- g1
D&7 D,+1 > g&
Dt7 D,+1 > gt
'f g is constant) the discounted di(idend
formula con(erges to#
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Future Di(idends and 3heir PresentValues
tt
t-r1+
DPVD
+=
t, PVDP =
@
,.&:
Aears +t,
t,t -g1+DD +=
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hat happens if g rsE
'f g rs) the constant growth formulaleads to a negati(e stock price) whichdoes not make sense.
3he constant growth model can onl* beused if#
rs g.
g is e$pected to be constant fore(er.
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se the S!G to Calculate the Re/uiredRate of Return +rs
'f rRF7 ?H) r!7 1&H) and b 7 1.&) whatis the re/uired rate of return on the Irm"sstockE
rs 7 rRF> +r!J rRFb7 ?H > +1&H J ?H1.&
7 1H
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Find the 6$pected Di(idend Stream forthe Ke$t Aears and 3heir PVs
1.B?
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sing the constant growth model#
hat is the stock"s intrinsic (alueE
@,.&9,.,?
@&.1&
,.,
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D1will ha(e been paid out alread*. So)e$pected P1is the present (alue +as of
Aear 1 of D&) D) D8) etc.
Could also Ind e$pected P1as#
hat is the stock"s e$pected (alue)one *ear from nowE
@&.1,,.,
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Find 6$pected Di(idend Aield) Capital =ainsAield) and 3otal Return During First Aear
Di(idend *ield
7 D10P,7 @&.1&0@,.&9 7 ?.,H
Capital gains *ield
7 +P1J P,0P,
7 +@&.1, J @,.&90@,.&9 7 Capital gains *ield
7 ?.,H >
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3he di(idend stream would be a perpetuit*.
hat would the e$pected price toda*be)
if g 7 ,E
@1:.,.1
@&.,,
r
P!3
P;, ===
&.,, &.,,&.,,
, 1 & rs7 1H
9-1:
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Supernormal =rowth# hat if g 7 ,H for *ears before achie(ing long-run growth
of
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Valuing Common Stock with Konconstant=rowth
rs 7 1H
g 7 ,H g 7 ,H g 7 ,H g 7
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Find 6$pected Di(idend and Capital =ainsAields During the First and Fourth Aears
Di(idend *ield +Irst *ear
7 @&.
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Konconstant =rowth# hat if g 7 ,H for *ears before long-run growth of
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Find 6$pected Di(idend and Capital =ainsAields During the First and Fourth Aears
Di(idend *ield +Irst *ear
7 @&.,,0@&:.?& 7 ?.?BH
Capital gains *ield +Irst *ear
7 1.,,H J ?.?BH 7 :.&&H
5fter t 7 ) the stock has constant growthand di(idend *ield 7 ?H) while capital
gains *ield 7
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Aes. 6(en though the di(idends aredeclining) the stock is still producing cashOows and therefore has positi(e (alue.
'f the stock was e$pected to ha(e negati(egrowth +g 7 -
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Find 6$pected 5nnual Di(idend andCapital =ains Aields
Capital gains *ield
7 g 7 -
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Corporate Valuation !odel
5lso called the free cash Oow method.Suggests the (alue of the entire Irme/uals the present (alue of the Irm"sfree cash Oows.
Remember) free cash Oow is the Irm"safter-ta$ operating income less the netcapital in(estment.
+
+= KC
ese$penditurCapital
onamorti%ati
andDepr.3-6Q'3+1FCF
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5ppl*ing the Corporate Valuation!odel
Find the market (alue +!V of the Irm) b*Inding the PV of the Irm"s future FCFs.
Subtract !V of Irm"s debt and preferred
stock to get !V of common stock. Di(ide !V of common stock b* the
number of shares outstanding to getintrinsic stock price +(alue.
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'ssues Regarding the CorporateValuation !odel
ften preferred to the discounteddi(idend model) especiall* whenconsidering number of Irms that don"tpa* di(idends or when di(idends are hard
to forecast.
Similar to discounted di(idend model)assumes at some point free cash Oow willgrow at a constant rate.
Mori%on (alue +MVK represents (alue ofIrm at the point that growth becomesconstant.
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MV,
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hat is the Irm"s intrinsic (alue pershareE
9-&?
3he Irm has @8, million total in debtand preferred stock and has 1, millionshares of common stock.
million98.?
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Firm !ultiples !ethod
5nal*sts often use the following multiplesto (alue stocks.
P06
P0CF
P0Sales
65!PG6# Qased on comparable Irms)estimate the appropriate P06. !ultipl*this b* e$pected earnings to back out anestimate of the stock price.
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6V5 5pproach
6V5 7 6/uit* capital+R6 J Cost of e/uit*
!V6/uit*7 QV6/uit*> PV of all future 6V5s
Value per share 7 !V6/uit*0 of shares
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Preferred Stock
M*brid securit*.
Gike bonds) preferred stockholdersrecei(e a I$ed di(idend that must be
paid before di(idends are paid tocommon stockholders.
Mowe(er) companies can omit preferreddi(idend pa*ments without fear ofpushing the Irm into bankruptc*.
9-,
'f preferred stock with an annual di(idend of @:
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'f preferred stock with an annual di(idend of @:sells for @:,) what is the preferred stock"s
e$pected returnE
1,H,.1,
@:,
@:r;
r
@:@:,
r
DV
p
p
p
p
==
=
=
=
9-1