FIN320-CH8 - Chapter 8 Valuation and Characteristics of...

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Unformatted text preview: Chapter 8 Valuation and Characteristics of Stock Security Valuation s In general, the intrinsic value of In intrinsic an asset = the present value of the present stream of expected cash flows discounted at an appropriate required rate of return. required Preferred Stock A hybrid security: s it’s like common stock - no fixed maturity. it’s maturity. x technically, it’s part of equity capital. s it’s like debt - preferred dividends are it’s fixed. fixed. x missing a preferred dividend does not missing constitute default, but preferred dividends are cumulative. cumulative Preferred Stock Preferred s Usually sold for $25, $50, or $100 per Usually share. share. s Dividends are often quoted as a Dividends percentage of par. percentage Preferred Stock s Usually sold for $25, $50, or $100 per Usually share. share. s Dividends are often quoted as a Dividends percentage of par. percentage x Example: In 1988, Xerox issued $75 million of 8.25% preferred stock at $50 per share. per Preferred Stock s Usually sold for $25, $50, or $100 per Usually share. share. s Dividends are often quoted as a Dividends percentage of par. percentage x Example: In 1988, Xerox issued $75 million of 8.25% preferred stock at $50 per share. per x $4.125 is the fixed, annual dividend per $4.125 share. share. Preferred Stock s May be callable and convertible. May callable convertible s Is usually non-voting. Is non-voting s Priority: lower than debt, higher than lower common stock. common s Usually includes protective provisions. Usually protective s May include a sinking fund provision. May sinking Preferred Stock Valuation s A preferred stock can usually be preferred valued like a perpetuity: valued Vps = D k ps Example: s Xerox preferred pays an 8.25% Xerox 8.25% dividend on a $50 par value. $50 s Suppose our required rate of Suppose return on Xerox preferred is 9.5%. 9.5% Example: s Xerox preferred pays an 8.25% Xerox 8.25% dividend on a $50 par value. $50 s Suppose our required rate of Suppose return on Xerox preferred is 9.5%. 9.5% Vps = 4.125 .095 .095 = Example: s Xerox preferred pays an 8.25% Xerox 8.25% dividend on a $50 par value. $50 s Suppose our required rate of Suppose return on Xerox preferred is 9.5%. 9.5% Vps = 4.125 .095 .095 = $43.42 Expected Rate of Return on Preferred s Just adjust the valuation model: Expected Rate of Return on Preferred s Just adjust the valuation model: kps = D Po Example s If we know the preferred stock price If is $40, and the preferred dividend is $40 and $4.125, the expected return is: $4.125 Example s If we know the preferred stock price If is $40, and the preferred dividend is $40 and $4.125, the expected return is: $4.125 kps = D Po = 4.125 = 40 Example s If we know the preferred stock price If is $40, and the preferred dividend is $40 and $4.125, the expected return is: $4.125 kps = D Po = 4.125 = .1031 40 The Financial Pages: Preferred Stocks 52 weeks Yld Vol 52 Hi Lo Sym Div % PE 100s Close Hi 293/8 251/8 GenMotor pfG 2.28 8.8 … 27 25 7/8 s Dividend: $2.28 on $25 par value = 9.12% dividend rate. 9.12% Expected return: 2.28 / 25.875 = 8.8%. 8.8%. s Common Stock s is a variable-income security. is variable-income x dividends may be increased or dividends decreased, depending on earnings. decreased, s represents equity or ownership. represents or s includes voting rights. includes voting s Priority: lower than debt and lower preferred. Common Stock Characteristics Claim on Income - a stockholder has a claim on the firm’s residual income. claim s Claim on Assets - a stockholder has a residual claim on the firm’s assets in case of liquidation. of s Preemptive Rights - stockholders may share proportionally in any new stock issues. s Voting Rights - right to vote for the firm’s board of directors. board s Common Stock Valuation (Single Holding Period) You expect XYZ stock to pay a $5.50 You $5.50 dividend at the end of the year. The stock price is expected to be $120 at that time. $120 s If you require a 15% rate of return, what If 15% would you pay for the stock now? would s Common Stock Valuation (Single Holding Period) You expect XYZ stock to pay a $5.50 You $5.50 dividend at the end of the year. The stock price is expected to be $120 at that time. $120 s If you require a 15% rate of return, what If 15% would you pay for the stock now? would s ? 0 5.50 + 120 1 Common Stock Valuation (Single Holding Period) Financial Calculator solution: P/Y =1, I = 15, n=1, solve: PV = -109.13 or: P/Y =1, I = 15, n=1, P/Y PMT = 5.50 PMT solve: PV = -109.13 FV= 125.50 FV= 120, The Financial Pages: Common Stocks 52 weeks Yld Vol Net 52 Hi Lo Sym Div % PE 100s Hi Lo Close Chg 139 81 IBM .48 .5 26 56598 108 106 1065/8 -2 119 75 MSFT +1/4 … 60 254888 96 93 953/8 Common Stock Valuation (Multiple Holding Periods) s Constant Growth Model s Assumes common stock dividends Assumes will grow at a constant rate into the future. the Common Stock Valuation (Multiple Holding Periods) s Constant Growth Model s Assumes common stock dividends Assumes will grow at a constant rate into the future. the Vcs = D1 kcs - g s Constant Growth Model s Assumes common stock dividends will grow Assumes at a constant rate into the future. s Constant Growth Model s Assumes common stock dividends will grow Assumes at a constant rate into the future. at Vcs = D1 kcs - g s Constant Growth Model s Assumes common stock dividends will grow Assumes at a constant rate into the future. at Vcs = s D1 kcs - g D1 = the dividend at the end of period 1. s kcs = the required return on the common stock. stock. s g = the constant, annual dividend growth rate. rate. Example s XYZ stock recently paid a $5.00 XYZ recently $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. 10% What would we be willing to pay if our required return on XYZ stock is 15%? 15% Example s XYZ stock recently paid a $5.00 XYZ recently $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. 10% What would we be willing to pay if our required return on XYZ stock is 15%? 15% D0 = $5, so D1 = 5 (1.10) = $5.50 Example s XYZ stock recently paid a $5.00 XYZ recently $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. 10% What would we be willing to pay if our required return on XYZ stock is 15%? 15% Vcs = Example s XYZ stock recently paid a $5.00 XYZ recently $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. 10% What would we be willing to pay if our required return on XYZ stock is 15%? 15% Vcs = D1 kcs - g = Example s XYZ stock recently paid a $5.00 XYZ recently $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. 10% What would we be willing to pay if our required return on XYZ stock is 15%? 15% Vcs = D1 kcs - g = 5.50 .15 - .10 = Example s XYZ stock recently paid a $5.00 XYZ recently $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. 10% What would we be willing to pay if our required return on XYZ stock is 15%? 15% Vcs = D1 kcs - g = 5.50 .15 - .10 = $110 Expected Return on Common Stock s Just adjust the valuation model Expected Return on Common Stock s Just adjust the valuation model Vcs = D kcs - g Expected Return on Common Stock s Just adjust the valuation model Vcs = D1 kcs - g Kcs = ( D1 Vcs )+g Expected Return on Common Stock s Just adjust the valuation model Vcs = D kcs - g k= ( D1 Po )+g Example s We know a stock will pay a $3.00 We $3.00 dividend at time 1, has a price of $27 $27 and an expected growth rate of 5%. 5% Example s We know a stock will pay a $3.00 We $3.00 dividend at time 1, has a price of $27 $27 and an expected growth rate of 5%. 5% kcs = ( D1 Po )+g Example s We know a stock will pay a $3.00 We $3.00 dividend at time 1, has a price of $27 $27 and an expected growth rate of 5%. 5% kcs = kcs = ( ( D1 Po )+g = 3.00 27 ) + .05 Example s We know a stock will pay a $3.00 We $3.00 dividend at time 1, has a price of $27 $27 and an expected growth rate of 5%. 5% kcs = kcs = ( ( D1 Po )+g = 16.11% 3.00 27 ) + .05 ...
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