Professional Documents
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taufikur@ugm.ac.id
Legal Rights and Privileges
of Common Stockholders
Represents ownership.
Ownership implies control.
Stockholders elect directors.
Directors elect management.
Managements goal: Maximize stock price.
Social/Ethical Question
Should management be equally concerned about employees,
customers, suppliers, the public, or just the stockholders?
In enterprise economy, work for stockholders subject to
constraints (environmental, fair hiring, etc.) and competition.
Types of Common Stocks
Classified stock has special provisions.
Could classify existing stock as founders
shares, with voting rights but dividend
restrictions.
New shares might be called Class A
shares, with voting restrictions but full
dividend rights.
The Market for Common Stock
^
P1 P0
Expected Capital gain yield P0
^
Expected total return r s = D1
+ ^
P1 P 0
P0 P0
Dividend growth model
D1 = D0(1 + g)1
D2 = D0(1 + g)2
Dt = D0(1 + g)t
If g is constant, then:
^ D0(1 + g) D1
P0 = = .
rs - g rs - g
Example
RT & T just paid a dividend of $1.15, its stock has a
required rate of return, ks, of 13,4%, and investors expect
the dividend to grow at a constant 8 % rate in the future.
The estimated dividend one year hence would be
D1 = $1.15(1.08) = $1.24
D2 = $1.34
D5 = $1.69
Using Gordon Model, we can know the intrinsic value of
stock (P^ 0)=
^
P0 = $1.15 (1.08) = $23
0.134 0.08
Present Values of Dividends of a Constant Growth Stock
$
D t = D0 (1 + g)
t
Dt
1.15
PVDt =
PV D1 = 1.10 (1 + r )t
P0 = PVD t
0 Years (t)
What happens if g > ks?
^ D1
P0 = requires r s > g.
rs -g
0 g = 6% 1 2 3
^ D2 $2.247
P1 = =
ks g 0.13 0.06
= $32.10.
^1 as follows:
Could also find P
^ = P (1.06) = $32.10.
P1 0
Find the expected dividend yield,
capital gains yield, and total return
during the first year.
D1 $2.12
Dividend yld = = = 7.0%.
P0 $30.29
^
P1 P0 $32.10 $30.29
Cap gains yld = =
P0 $30.29
= 6.0%.
Total return = 7.0% + 6.0% = 13.0%.
Rearrange model to rate of return form:
D1 D1
P0 = to r s = + g.
^ ^
rs-g P0
^
Then, rs = $2.12/$30.29 + 0.06
= 0.07 + 0.06 = 13%.
^
What would P0 be if g = 0?
The dividend stream would be a
perpetuity.
0 1 2 3
13% ...
2.00 2.00 2.00
^ PMT $2.00
P0 = = = $15.38.
r 0.13
For a Constant Growth Stock
The following conditions must hold:
1. The dividend is expected to grow forever at a
constant rate, g
2. The stock price is expected to grow at this same
rate
3. The expected dividend yield is a constant
4. The expected capital gain yield is also a constant,
and it is equal to g
^
5. The expected total rate of return, r s, is equal to the
expected
^ dividend yield plus the expected growth
rate: r s= dividend yield + g
If we have supernormal growth of 30%
for 3 years, then a long-run constant
^
g = 6%, what is P0? k is still 13%.
Can no longer use constant growth model.
However, growth becomes constant after 3 years
(terminal/horizon date: the date when the growth rate
becomes constant)
3 Steps for nonconstant growth:
Find the PV of the dividends during the period of
nonconstant growth
Find the price of the stock at the end of the noncontstant
growth period, at which point has become a constant
growth stock, and discount this price back to the present
Add this two components to find the intrinsic value of the
^
stock, P0
Nonconstant growth followed by constant
growth:
0 r = 13% 1 2 3 4
s ...
g = 30% g = 30% g = 30% g = 6%
D0 = 2.00 2.600 3.380 4.394 4.658
2.301
2.647
3.045
4.658
.
46.116 P$ 3 = = $66.54
^ 0 .13 - 0.06
54.109 = P0
What is the expected dividend yield
and capital gains yield at t = 0?
At t = 4?
$2.60
Div. yield0 = = 4.81%.
$54.11
0 1 2 3 4
ks=13%
...
g = 0% g = 0% g = 0% g = 6%
2.00 2.00 2.00 2.00 2.12
1.77
1.57
1.39 2.12
20.99 $ =
P = 30.29.
3
25.72 0.07
What is D/P and capital gains yield at
t = 0 and at t = 3?
D1 $2.00
t = 0: = = 7.78%.
P0 $25.72
CGY = 13% 7.78% = 5.22%.
t = 3: Now have constant growth
with g = capital gains yield = 6% and
D/P = 7%.
If g = -6%, would anyone buy the
stock? If so, at what price?
$0 = D 1 D0
(1 + g)
P =
rs -g rs -g
$2.00(0.94) $1.88
= = = $9.89.
0.13 (-0.06) 0.19
What is the annual D/P and capital
gains yield?
(More...)
FCF Method Issues Continued
^
rs = D1/P0 + g = rs = rRF + (rM rRF)b.
Expected returns are obtained by
estimating dividends and expected
capital gains (which can be found
using any of the three common stock
valuation approaches).
^
rs = D1/P0 + g = rs = rRF + (rM rRF)b.
How is equilibrium established?
^ D1
If ks = + g > ks, then
P0
P0 is too low (a bargain).
^ D1
P0 =
ri g
1. ki could change:
ki = rRF + (rM rRF )bi.
rRF = k* + IP.
$5
V p = $50 =
rp
$5
rp = = 0.10 = 10.0%.
$50