Chapter 8-11 Finance NOTES.docx - Chapter 8-10 Finance...

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Chapter 8-10 Finance CHAPTER 8: Valuation and Characteristics of Stocks Common Stock can last forever. (Stock does not have a maturity/ or a par value) Security Valuation: In General, the intrinsic value of an asset = the present value of the stream of expected cash flows. Discounted at an appropriate required rate of return. Expected Return vs. Required Return o Expected Return is the return that an investor expects to earn on an asset given its price, growth potential, etc. o Required Return is the return that an investor requires on an asset, given its risk and market interest rates. Preferred Stock Valuation : Preferred stockholders pay high dividends, and the dividend is fixed. a preferred stock can usually be valued like a perpetuity: Value of PS = (D) Dividends over (Kps) Required return EXAMPLE: Xerox Preferred pays and 8.25% dividend on a 50$ par Value. (no standard par value) Suppose our required rate of return is 9.5% (.0825 x 50 = 4.125) Pecking order of liquidation: 1. In the event of liquidation bondholders (creditors) have a highest priority of receiving money first 2. Preferred stockholders would be next 3. Common stockholders are last in pecking order Expected Rate of Return on Preferred: Just adjust the valuation model: Dividends over Po (Price) EXAMPLE: If we know the Preferred stock price is 40$ and the preferred dividend is $4.125 the expected return is: Common Stock Valuation : (single holding period) You expect XYZ Stock to pay a 5.5$ dividend at the end of the year. The stock price is expected to be $120 at that time. If you require a 15% rate of return what would you pay
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