Notes #3 - Finance EXAM#2 102 Equity Valuation...

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Finance EXAM#2 102 Equity Valuation Characteristics of Stock - Shareholders (SH) are ultimate owners of the company - SHs have residual claim on assets and income - Limited Liability- limited to the amount of the investment - No maturity Stock Valuation Number of shares Outstanding – held by public Issued – Sold OR Authorized Number dictated by company charter, maximum number they can issue OR Treasury Stocks – have been issued and repurchased Reserve – stock options (employees), merger Par Value – Set very low, only for tracking period How does a firm sell new shares of stock in the market? Hire an Investment Banker (IB) Three Functions of an IB: 1) Acts as an advisor 2) Acts as an underwriter – Ex. IB buys all shares from Ford at $70/share 3) Acts as a sales person Firm’s Perspective Advantages - No fixed charges
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- No maturity (no refinancing/refunding) - Lowers the financial risk of the firm Disadvantages - Increase the # of shares – dilution of earnings and dividends - More expensive than debt - Dividends are not tax deductible Preferred Stock – (hybrid b/w common stock and bonds) - infinite maturity - pays a fixed/ constant dividend - par value is specified – usually $50 or $100 per share Ex. Preferred par value = $50 Divided Rate = 12% Dividend = .12(50)=$6 0 1 2 3 4 5 6 infinite 6 6 6 6 6 6 6 PV of Perpetuity PVperp=PMT/I D/Kp Kp = required rate of return for preferred stockholders with similar characteristics If Kp=10% 6/.1=$60 Common Stock Dividends Capitial Gains Initially – analyze from the perspective of an investor who buys stock and holds it for 10 years (find value or price) 0 1 2 3 4 5 6 7 8 9 10 D1 D2 D3 D4 D5 D6 D7 D8 D9 D10+P10 Po=D1/(1+Ke)^1+D2/(1+Ke)^2+D3/(1+Ke)^3…….+(D10+P10)/(1+Ke)^10 Ke=appropriate rate of return given by the market, common stockholders required rate of return P10=?=D11/(1+Ke)^1+D12(1+Ke)^2 Assumptions about the dividend behavior 1) Normal Growth D1=Do(1+g)^1 Do=”Dividend paid yesterday” =”last dividend” D2=Do(1+g)^2 OR D1(1+g)^1 Dt=Do(1+g)^t
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If 2 conditions hold we can use calculus - the constant growth rate lasts forever - Ke>g Then Po=D1/Ke-g Value of common stock w/ normal growth dividend Po=Do(1+g)^1/Ke-g
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This note was uploaded on 08/31/2009 for the course DRXL 100 taught by Professor All during the Spring '09 term at Drexel.

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Notes #3 - Finance EXAM#2 102 Equity Valuation...

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