5thCh9

# 5thCh9 - CHAPTER 9 Stocks and Their Valuation Determining...

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CHAPTER 9 Stocks and Their Valuation Determining common stock values Preferred stock

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Determinants of Intrinsic Value  and Stock Prices (Figure 1-1)
Dividend growth model Free cash flow method Using the multiples of comparable  firms Different Approaches for  Valuing Common Stock

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Valuing Common Stock Valuing these uncertain payments is difficult Stock Valuation Single Period Multiperiod Zero Constant Variable
Single Period Valuation Example You are interested in the stock of Testard, Inc. You can expect to receive a dividend of \$1.20 in one year. Your broker estimates that the stock should be worth \$38 next year. Given its risk, the discount rate is 12%. If you can purchase the stock for \$30, should you buy it? 1 1 0 1 Div P P r + = + 35 \$ 12 . 1 38 \$ 20 . 1 \$ 0 = + = Π

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Multiperiod Valuation What is the maturity of a share of common stock? A share of stock is a claim on a corporation that has an indefinite life, we can treat the stock valuation as an infinite stream, and value it as a perpetuity. ( 29 ( 29 ( 29 3 1 2 0 2 3 1 1 1 1 Div Div Div Div P r r r r i i = + + + + + + + + L ( 29 0 1 1 t t t Div P r i = = + a
Zero Dividend Growth Div Div Div Div = = = = L 2 1 ( 29 = , 0 r PVIFA Div P 0 Div P r = Value of a share of stock with constant dividends is a calculated as a level perpetuity.

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Zero Dividend Growth Example You have inherited stock in your family’s boring old business. It pays, and will pay as it has for years, an annual dividend of \$3. Your sister has offered to purchase this stock. Given its discount rate of 15%, what would be a fair price for her to pay? 0 \$3 \$20 0.15 Div P r = = =
Growth Often assume dividends grow at a  constant rate Regular growth rates often a managerial  goal Regular growth in dividends often a  good approximation Means we can use the growing  perpetuity formula to value stocks

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Constant Dividend Growth ( 29 ( 29 ( 29 ( 29 ( 29 2 0 0 1 0 2 1 1 1 1 1 1 Div g Div g Div g P r r r i i + + + = + + + + + + L ( 29 t t g Div Div + = 1 0 ( 29 0 1 0 1 Div g Div P r g r g + = = - - G = growth rate in dividends Assume it is constant over stated horizon
Dividend Growth Example Your sister, after buying your stock, fired your parents as managers of the family business. The changes she then made to the company have increased productivity and caused expected dividends to increase by 5%/year indefinitely, without changing the discount rate. How much is the stock worth now? ( 29

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## This note was uploaded on 04/18/2008 for the course BMGT 350 taught by Professor Boyd during the Spring '08 term at Maryland.

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5thCh9 - CHAPTER 9 Stocks and Their Valuation Determining...

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