chap09 - Chapter 9 Stocks and Their Valuation 2 Topics...

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Chapter 9 Stocks and Their Valuation
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Topics Covered Common and Preferred Stock Properties Valuing Preferred Stocks Valuing Common Stocks - the Dividend Growth  Model No growth Constant growth Non-constant or supernormal growth Valuing the Entire Corporation – Free Cash Flow  Approach Stock Market Equilibrium 2
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Facts about common stock Represents ownership Ownership implies control Stockholders elect directors Directors elect management Management’s goal: Maximize the stock price 3
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Preferred Stock Characteristics Unlike common stock, no ownership interest Second to debt holders on claim on company’s  assets in the event of bankruptcy. Annual dividend yield as a percentage of par  value Preferred dividends must be paid before common  dividends If cumulative preferred, all missed past dividends  must be paid before common dividends can be  paid. 4
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Intrinsic Value and Stock Price Outside investors, corporate insiders, and  analysts use a variety of approaches to  estimate a stock’s intrinsic value (P 0 ). In equilibrium we assume that a stock’s price  equals its intrinsic value. Outsiders estimate intrinsic value to help  determine which stocks are attractive to buy  and/or sell. Stocks with a price below (above) its intrinsic  value are  undervalued  ( overvalued ). 5
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Preferred Stock Valuation Promises to pay the same dividend year after  year forever, never matures. A perpetuity. V P  = D P /r P Expected Return: r P  = D P /P 0 Example:  GM preferred stock has a $25 par  value with a 8% dividend yield.  What price  would you pay if your required return is 7%? 6
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What do investors in common stock want? Periodic cash flows: dividends, and… To sell the stock in the future at a higher price Management to maximize their wealth 7
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Stock Valuation: Dividend Growth Model Stock Value = PV of  Future  Expected Dividends ( 29 ( 29 ( 29 ( 29 + + + + + + + + = r D r D r D r D P 1 . . . 1 1 1 3 3 2 2 1 1 0 8
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Stock Valuation: Dividend Patterns For Valuation: we will assume stocks fall into  one of the following dividend growth patterns. Constant growth rate in dividends Zero growth rate in dividends, like preferred stock Variable (non-constant) growth rate in dividends 9
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We have found the following information for  Doh! Doughnuts: current dividend = $2.00 = Div
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This note was uploaded on 02/27/2009 for the course FIN 221 taught by Professor Dyer during the Fall '08 term at University of Illinois at Urbana–Champaign.

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chap09 - Chapter 9 Stocks and Their Valuation 2 Topics...

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