CH08 - CHAPTER 8 Valuation and Characteristics of Stock...

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CHAPTER 8 Valuation and Characteristics of Stock Orientation : This chapter continues the introduction of concepts underlying asset valuation began in Chapter 7. We are specifically concerned with valuing preferred stock and common stock. We also look at the concept of a stockholder’s expected rate of return on an investment. I. Preferred Stock A. Features of preferred stock 1. Owners of preferred stock receive dividends instead of interest. 2. Most preferred stocks are perpetuities (non-maturing). 3. Multiple series, each having different characteristics, can be issued. 4. Preferred stock has priority over common stock with regard to claims on assets in the care of bankruptcy. 5. Most preferred stock carries a cumulative feature that requires all past unpaid preferred stock dividends to be paid before any common stock dividends are declared. 6. Preferred stock may contain other protective provisions. 7. Preferred stock may contain provisions to convert to a predetermined number of shares of common stock. 99
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8. Retirement features for preferred stock are frequently included. a. Callable preferred refers to a feature which allows preferred stock to be called or retired, like a bond. b. A sinking fund provision requires the firm periodically to set aside an amount of money for the retirement of its preferred stock. B. Valuation of preferred stock (V ps ): The value of a preferred stock equals the present value of all future dividends. If the stock is nonmaturing, where dividends are expected in equal amount each year in perpetuity, the value may be calculated as follows: V ps = return of rate required dividend annual = ps k D II. Common Stock A. Features of Common Stock 1. As owners of the corporation, common shareholders have the right to the residual income and assets after bondholders and preferred stockholders have been paid. 2. Common stock shareholders are generally the only security holders with the right to elect the board of directors. 3. Preemptive rights entitles the common shareholder to maintain a proportionate share of ownership in the firm. 4. Common stock shareholders liability as owners of the corporation is limited to the amount of their investment. 5. Common stock’s value is equal to the present value of all future cash flows expected to be received by the stockholder. B. Valuing common stock 1. Company growth occurs either by: a. The infusion of new capital. 100
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b. The retention of earnings, which we call internal growth. The internal growth rate of a firm equals: Return on equity X firm e within th retained earnings of Percentage 2. The earnings growth of a firm should be reflected in a higher price for the firm's stock. 3.
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This note was uploaded on 04/16/2008 for the course FIN 100 taught by Professor N/a during the Spring '08 term at Baylor.

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CH08 - CHAPTER 8 Valuation and Characteristics of Stock...

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