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Unformatted text preview: 350-08a_note, 11S Page 1 of 15 TOPIC 8: STOCK AND THEIR VALUATION (CHAPTER 9) I.Outline A.Features of stock 1.Common stock 2.Preferred stock B.Stock Valuation Models 1.Dividend Model a)Constant Growth Model b)Non-Constant Growth Model 2.FCF Model C.Market Equilibrium II.Homework Assignment Chapter9Question1, 4-5Problem1, 2, 4-7, 12-15, A-1, A-2================================================================ Class Notes I.Features of Stock (Case A) A.Facts about Common Stock 1.Represents ownership 2.Ownership implies control 3.Stockholders elect directors 4.Directors elect management 5.Management’s goal: Maximize the stock price 6.Different classes of common stocks B.Facts about Preferred stock 1.Hybrid security. 2.Like bonds, preferred stockholders receive a fixed dividend that must be paid before dividends are paid to common stockholders. 3.However, companies can omit preferred dividend payments without fear of pushing the firm into bankruptcy. C.Intrinsic Value and Stock Price 1.Outside investors, corporate insiders, and analysts use a variety of approaches to estimate a stock’s intrinsic value ˆPPIV2.In equilibrium we assume that a stock’s market price (P) equals its intrinsic value (ˆP) 3.Outsiders estimate intrinsic value to help determine which stocks are attractive to buy and/or sell. 4.Stocks with a price below (above) its intrinsic value are undervalued(overvalued). 350-08a_note, 11S Page 2 of 15 II.Stock Valuation Models: Dividend Growth Model A.Basics (Case B) 1.Value of a stock is the present value of the future dividends expected to be generated by the stock. )r(1D...)r(1D)r(1D)r(1Dˆs3s32s21s1PPIVB.Constant Growth Stock 1.A stock whose dividends are expected to grow forever at a constant rate, g. 2.The dividend growth formula converges to: - grD- grg)(DrgDrgDrgDPPsssssIV13322111......11*11*11*ˆ3.Constant Growth Stock Example 1: Risk-free rate, rRF= 7%. Market return rate, rM= 12%. Company has a market beta, b = 1.2. D= $2. Dividend growth rate, g = 6%. What is the required rate of return on the firm’s stock? Assume the stock is currently traded at $29, what is its estimated (predicted) rate of return? Should you buy or sell this stock? a)Q1: What is the required rate of return on the firm’s stock? (Case C) b)Q2: What is the expected dividend stream for the next 4 years? What should be the current stock price (the stock’s intrinsic value)? (Case D) c)Q3: What is its expected value (the intrinsic value) one year from now? What are the expected dividend yield, capital gains yield, and total return during the first year?...
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