Ch 7 Slide Show

Ch 7 Slide Show - 1 CHAPTER 7 Stocks, Stock Valuation, and...

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Unformatted text preview: 1 CHAPTER 7 Stocks, Stock Valuation, and Stock Market Equilibrium 2 Topics in Chapter Features of common stock Valuing common stock Preferred stock Stock market equilibrium Efficient markets hypothesis Implications of market efficiency for financial decisions 4 Common Stock: Owners, Directors, and Managers Represents ownership. Ownership implies control. Stockholders elect directors. Directors hire management. Since managers are agents of shareholders, their goal should be: Maximize stock price. 5 Classified Stock 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. 6 Tracking Stock 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. 7 Different Approaches for Valuing Common Stock Dividend growth model Constant growth stocks Nonconstant growth stocks Free cash flow method (covered in Chapter 11) Using the multiples of comparable firms 8 Stock Value = PV of Dividends What is a constant growth stock? One whose dividends are expected to grow forever at a constant rate, g. P = ^ (1 + r s ) 1 (1 + r s ) 2 (1 + r s ) 3 (1 + r s ) D 1 D 2 D 3 D + + + + 9 For a constant growth stock: D 1 = D (1 + g) 1 D 2 = D (1 + g) 2 D t = D (1 + g) t If g is constant and less than r s , then: P = ^ D (1 + g) r s g = D 1 r s g 10 Dividend Growth and PV of Dividends: P = (PV of D t ) $ 0.25 Years (t) D t = D (1 + g) t PV of D t = D t (1 + r) t If g > r, P = ! 11 What happens if g > r s ? P = ^ (1 + r s ) 1 (1 + r s ) 2 (1 + r s ) D (1 + g) 1 D (1 + g) 2 D (1 + r s ) + + + (1 + g) t (1 + r s ) t P = ^ > 1, and So g must be less than r s for the constant growth model to be applicable!! If g > r s , then 12 Required rate of return: beta = 1.2, r RF = 7%, and RP M = 5%. r s = r RF + (RP M )b Firm = 7% + (5%)(1.2) = 13%....
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This note was uploaded on 02/02/2011 for the course FINC 350 taught by Professor Johnson during the Spring '11 term at UCLA.

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Ch 7 Slide Show - 1 CHAPTER 7 Stocks, Stock Valuation, and...

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