Professional Documents
Culture Documents
1
What is Value?
2
Several Kinds of “Value”
v Note that the intrinsic value of an asset can be, and often
is, different for each individual (that’s what makes
markets work)
4
Chapter 2:
Valuation of Stocks and Bonds
5
Preferred Stock Features
v Preferred stock differs from common stock because it has preference over
common stock on payment of dividends and in the distribution of
corporation assets in the event of liquidation.
v Preferred stock is a form of equity from a legal, tax, and regulatory
standpoint.
v Holders of preferred stock generally have no voting privileges.
v However, holders of preferred stock are often granted voting and other
rights if preferred dividends have not been paid for some time.
v Preferred stock have a stated liquidating value.
v The cash dividend is described in dollars per share.
v A preferred dividend is not like bond interest
v Dividends on preferred stock are either cumulative or non-cumulative.
v Dividends not declared on cumulative preferred stock are carried
forward and must be paid before common shareholders can receive
anything
6
Features of preferred stock
v A hybrid security
v May be perpetuity or redeemable
v Paid before common dividends.
v Cumulative or Non-cumulative dividends
v Dividends not a liability
v Protective provisions (voting)
v Call provisions & sinking funds
v Convertible or Non-convertible
v Usually non-voting and non-participative.
v Priority-lower than debt, higher than stock.
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Preferred Stock Valuation
Vp = D
kp
8
Example:
4.125
Vp = = $43.42
.095
9
Expected Rate of Return on Preferred
D
kp =
Vp
D
kp =
Po
10
Example
D 4.125
kp = = = .1031
Po 40
11
Valuation of redeemable preferred stock
v The value of a preferred stock equals the present value of all
future dividends
n
D M
Vp
t 1 (1 k p ) (1 k p ) n
t
13
Features of common stock
v Residual income and asset claimants
• Unlimited upside
• First to suffer
v Priority
1. Debt
2. Preferred Stock
3. Common Stock
v A firm cannot go bankrupt for not declaring dividends
v Dividends and Taxes
• Dividend payments are not considered a business
expense, therefore, they are not tax deductible
• Dividends received by individuals are taxed as ordinary
income
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Features of Common Stock
15
Common Stock Features
Dividends
17
Common Stock Features
Classes of Stock
18
Common Stock Valuation
19
Cash flows for stockholders
20
Common Stock Valuation
21
Some Notes About Common Stock
22
Common Stock: Some Assumptions
23
Common Stock Valuation:
Dividend Discount Model
24
Single-Period Valuation Model
v Suppose you are thinking of purchasing the stock of Moore Oil, Inc.
and you expect it to pay a $2 dividend in one year and you believe
that you can sell the stock for $14 at that time. If you require a return
of 20% on investments of this risk, what is the maximum you would
be willing to pay?
D1 P1
Vc
(1 k c ) (1 k c )
25
Single Holding Period
? 5.50 + 120
0 1
Ans: $ 109.13
26
What happens if ?
D1 Po (1 g ) D1
Po
(1 k c ) (1 k c ) (k c g )
27
Example
D1 2
Po Rs 20.00
(k c g) (0.15 0.05)
28
Expected Rate of Return
Kc = (D1 / Po)+ g
29
Multi-period Valuation Model
D1 D2 D3 D4 Dn Pn
P0 ...........
1 k c (1 k c ) (1 k c ) (1 k c )
2 3 4
(1 k c ) n
(1 k c ) n
n
Dt Pn
t 1 (1 k c ) (1 k c ) n
t
30
Multi-period Valuation Model
31
Multi-period Valuation Model
32
Commonly used assumptions types:
33
Zero Growth Model
Assuming that the dividend per share remains
constant year after year, at a value of D, the
valuation model becomes as that of the
perpetual preference stock;
D D D D D
P0 ...........
1 k c (1 k c ) (1 k c ) (1 k c )
2 3 4
(1 k c )
D D
t 1 (1 k c )
t
kc
34
Example
D 0.5
P0 $ 20.00
k c 0.025
35
Constant Growth model
D 0 (1 g) D1
P0
kc - g kc - g
36
Example 1
37
Example 2
Ans: $ 13.33
38
Example 3
2(1.05)
P0 $42
(.10 .05)
39
Example 4
40
What drives growth ?
41
Financials of Omega Limited
Dividends
Retention Ratio
Retained earnings
44
Estimation of Growth
v The growth rate in dividends
(g) can be estimated in a
number of ways.
45
Two Stage Growth Model
D1 D1 (1 g1 ) D1 (1 g1 ) 2 D1 (1 g1 ) n 1 Pn
P0 ......
1 k c (1 k c ) 2
(1 k c ) 3
(1 k c ) n
(1 k c ) n
46
Two Stage Growth Model (contd….)
47
Reminder: Present Value of a Growing annuity
If ,
A(1 g) cash flow at the end of 1st year
A(1 g) 2 cash flow at the end of 2nd year
A(1 g) n cash flow at the end of nth year
(1 r) n (1 g) n
PV of growing annuity A(1 g)
( r g ) (1 r) n
This is true for g r and g r but not for g r in the
case of which, PV shall be only nA.
48
Two Stage Growth Model (contd….)
1 g n
1 1
1 kc
D1
k c g1
49
Two Stage Growth Model (contd….)
Hence,
1 g n
1 1
1 kc Pn
P0 D1
(1 k ) n
k c g1
c
50
Two Stage Growth Model (contd….)
D n 1
Pn
kc g2
51
Two Stage Growth Model (contd….)
1 g n
1 1
1 k c D1 (1 g1 ) (1 g 2 )
n 1
1
P0 D1
n
k c g1
k c g1 (1 k c )
52
Example:
Ans: Rs 79.597
53
Non-constant growth
54
Non-constant growth – solution
55
Non-constant growth
56
Non-Constant Growth
57
Non-Constant Growth
Example:
v ABC Company does not plan to pay a dividend
until year 5. ABC’s expects the dividend in year
five to be $1 and dividends in future years to grow
at a constant rate of 5%. If the firm’s risk-adjusted
required rate of return is 13%, what is the value of
a share of stock in the company today?
Rearranging:
kc = r = D1/P0 + g
59
Components of Required Return
D t Pt Pt 1
r
Pt 1 Pt 1
60
Illustration:
We can verify this answer by calculating the price in one year P1 , using
15 % as the required return.
P1 = D1 (1+g) / (r – g)
= $ 1 x 1.10 / (0.15 -0.10)
= $ 22
Low
Growth
Firm
Normal
Growth
Firm
Supernorm
al Growth
Firm
65
Illustration (contd…)
66
Inference
68
Price Ratio Analysis
69
Price Ratio Analysis
70
Price Ratio Analysis
72
Price Ratio Analysis
73
Price Ratio Analysis
74
P/E Ratio Approach
P0
P0 E1
E1
where, P0 Estimated Price
E1 Estimated EPS
P0
Justified P/E Ratio
E1
75
Determinants of P/E Ratio
D1 E1 (1 b)
P0
r - g r ROE b
P0 (1 b)
E1 r ROE b
76
Determinants of P/E Ratio
77