FM8e- ch05 - 5-1 CHAPTER 5 Stocks and Their Valuation...

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5 - 1 CHAPTER 5 Stocks and Their Valuation Features of common stock Determining common stock values Efficient markets Preferred stock
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5 - 2 Represents ownership. Ownership implies control. Stockholders elect directors. Directors hire management. Since managers are “agents” of shareholders, their goal should be: Maximize stock price. Common Stock: Owners, Directors, and Managers
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5 - 3 Classified stock has special provisions. Could classify existing stock as founders’ shares, with voting rights but dividend restrictions. New shares might be called “Class A” shares, with voting restrictions but full dividend rights. What’s classified stock? How might classified stock be used?
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5 - 4 The dividends of tracking stock are tied to a particular division, rather than the company as a whole. Investors can separately value the divisions. Its easier to compensate division managers with the tracking stock. But tracking stock usually has no voting rights, and the financial disclosure for the division is not as regulated as for the company. What is tracking stock?
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5 - 5 When is a stock sale an initial public offering (IPO)? A firm “goes public” through an IPO when the stock is first offered to the public. Prior to an IPO, shares are typically owned by the firm’s managers, key employees, and, in many situations, venture capital providers.
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5 - 6 What is a seasoned equity offering (SEO)? A seasoned equity offering occurs when a company with public stock issues additional shares. After an IPO or SEO, the stock trades in the secondary market, such as the NYSE or Nasdaq.
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5 - 7 Dividend growth model Using the multiples of comparable firms Free cash flow method (covered in Chapter 10) Different Approaches for Valuing Common Stock
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5 - 8 ( 29 ( 29 ( 29 ( 29 + + + + + + + + = s s s s r D r D r D r D P 1 . . . 1 1 1 ˆ 3 3 2 2 1 1 0 One whose dividends are expected to grow forever at a constant rate, g. Stock Value = PV of Dividends What is a constant growth stock?
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5 - 9 For a constant growth stock, ( 29 ( 29 ( 29 D D g D D g D D g t t t 1 0 1 2 0 2 1 1 1 = + = + = + ( 29 g r D g r g D P s s - = - + = 1 0 0 1 ˆ If g is constant, then:
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5 - 10 ( 29 D D g t t = + 0 1 ( 29 t t t r D PVD + = 1 ! P r, > g 0 = If P PVD t 0 = ∑ $ 0.25 Years (t) 0
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What happens if g > r s ? If r s < g, get negative stock price, which is nonsense. We can’t use model unless (1) g < r s and (2) g is expected to be constant forever. Because g must be a long- term growth rate, it cannot be r s . . r
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FM8e- ch05 - 5-1 CHAPTER 5 Stocks and Their Valuation...

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