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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to apublicly accessible ebsite, in hole or in part.

!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

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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

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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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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a

'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

FFM - BH 13ed - CH09

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