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# Chapter 09 - CHAPTER 9 Stocks and Their Valuation Features...

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9-1 CHAPTER 9 Stocks and Their Valuation  Features of common stock Determining common stock values Preferred stock

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9-2 Facts about common stock Represents ownership Ownership implies control Stockholders elect directors Directors elect management Management’s goal: Maximize the  stock price
9-3 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 ).

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9-4 Determinants of Intrinsic Value  and Stock Prices (Figure 1-1)
9-5 Different approaches for estimating the  intrinsic value of a common stock Dividend growth model Corporate value model Using the multiples of comparable  firms

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9-6 Dividend growth model Value of a stock is the present value of the  future dividends expected to be generated by  the stock. + + + + + + + + = ) r (1 D     ...     ) r (1 D     ) r (1 D     ) r (1 D     P s 3 s 3 2 s 2 1 s 1 0 ^
9-7 Constant growth stock A stock whose dividends are expected to  grow forever at a constant rate, g. D 1  = D 0  (1+g) 1 D 2  = D 0  (1+g) 2 D t  = D 0  (1+g) t   If g is constant, the dividend growth formula  converges to: g   - r D     g   - r g) (1 D     P s 1 s 0 0 ^ = + =

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9-8 Future dividends and their  present values t 0 t   )   g     1   (   D D + = t t t )     1   ( D PVD + = t 0 PVD P = \$ 0.25 Years (t) 0
9-9 What happens if g > r s ? If g > r s , the constant growth formula  leads to a negative stock price, which  does not make sense. The constant growth model can only be  used if: r s  > g g is expected to be constant forever

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9-10 If r RF  = 7%, r M  = 12%, and b = 1.2, what  is the required rate of return on the firm’s  stock? Use the SML to calculate the required
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Chapter 09 - CHAPTER 9 Stocks and Their Valuation Features...

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