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Unformatted text preview: Stock Valuation
CH 8 Preferred Stock
A hybrid security: It’s like common stock no fixed maturity. Technically, it’s part of equity capital. It’s like debt preferred dividends are fixed. Missing a preferred dividend does not constitute default, but preferred dividends are cumulative. Preferred Stock Usually sold for $25, $50, or $100 per share.
Dividends are fixed either as a dollar amount or as a percentage of par value. Example: In 1988, Xerox issued $75 million of 8.25% preferred stock at $50 per share. $4.125 is the fixed, annual dividend per share. Preferred Stock Features Firms may have multiple classes of preferreds, each with different features. Priority: lower than debt, higher than common stock.
Cumulative feature: all past unpaid preferred stock dividends must be paid before any common stock dividends are declared. Preferred Stock Features Protective provisions are common.
Convertibility: many preferreds are convertible into common shares.
Adjustable rate preferreds have dividends tied to interest rates.
Participation: some (very few) preferreds have dividends tied to the firm’s earnings. Preferred Stock Features PIK Preferred: Payinkind preferred stocks pay additional preferred shares to investors rather than cash dividends.
Retirement: Most preferreds are callable, and many include a sinking fund provision to set cash aside for the purpose of retiring preferred shares. Common Stock
Common Is a variableincome security. Dividends may be increased or decreased, depending on earnings.
Represents equity or ownership.
Includes voting rights.
Limited liability: liability is limited to amount of owners’ investment.
Priority: lower than debt and preferred. Common Stock Characteristics
Common Claim on Income a stockholder has a claim on the firm’s residual income.
Claim on Assets a stockholder has a residual claim on the firm’s assets in case of liquidation.
Preemptive Rights stockholders may share proportionally in any new stock issues. Voting Rights right to vote for the firm’s board of directors. Security Valuation
Security 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. Preferred Stock
Valuation A preferred stock can usually be valued like a perpetuity: Vps = D
k ps Example: Xerox preferred pays an 8.25% dividend on a $50 par value. Suppose our required rate of return on Xerox preferred is 9.5%. Vps = 4.125
.095 = $43.42 Expected Rate of
Return on Preferred
Return Just adjust the valuation formula: Vps = D
k ps kps = D
Example If we know the preferred stock price is $40, and the preferred dividend is $4.125, the expected return is: kps = D
Po = 4.125
40 Common Stock Valuation
(Single Holding Period) You expect XYZ stock to pay a $5.50 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 for the stock now? ?
0 5.50 + 120
1 Common Stock Valuation
(Single Holding Period)
Vcs = (5.50/1.15) + (120/1.15) = 4.783 + 104.348 = $109.13 Common Stock Valuation
(Multiple Holding Periods) Constant Growth Model Assumes common stock dividends will grow at a constant rate into the future. Vcs = D1
kcs - g Constant Growth Model
Constant Growth Model Assumes common stock dividends will grow at a constant rate into the future. Vcs = D1
kcs - g D1 = the dividend at the end of period 1.
kcs = the required return on the c/s.
g = the constant, annual dividend growth rate. Example
Example XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%? D0 = $5, so D1 = 5 (1.10) = $5.50 Example
Example XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%? Vcs = D1
kcs - g = 5.50
.15 - .10 = $110 Expected Return on
Common Just adjust the valuation model Vcs = D
kcs - g k= k= ( D1
Po )+g ( D1
Vcs )+g Example
Example We know a stock will pay a $3.00 dividend at time 1, has a price of $27 and an expected growth rate of 5%. kcs = ( kcs = ( D1
Po )+g 3.00
27 ) + .05 = 16.11% ...
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