FIN 534 chapter 7 info

FIN 534 chapter 7 info - CHAPTER7 Stocks,StockValuation, and

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1 CHAPTER 7 Stocks, Stock Valuation,  and  Stock Market Equilibrium
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2 Topics in Chapter n Features of common stock n Valuing common stock n Preferred stock n Stock market equilibrium n Efficient markets hypothesis n Implications of market efficiency for  financial decisions
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ValueStock = + + + D1 D2 D∞ (1 + rs )1 (1 + rs)∞ (1 + rs)2 Dividends (Dt) Market interest rates Firm’s business risk Market risk aversion Firm’s debt/equity mix Cost of  equity (rs) Free cash  flow (FCF) The Big Picture: The Intrinsic Value of Common Stock ...
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4 Common Stock: Owners,  Directors, and Managers n Represents ownership. n Ownership implies control. n Stockholders elect directors. n Directors hire management. n Since managers are “agents” of  shareholders, their goal should be:   Maximize stock price.
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5 Classified Stock n Classified stock has special provisions. n Could classify existing stock as  founders’ shares, with voting rights but  dividend restrictions. n New shares might be called “Class A”  shares, with voting restrictions but full  dividend rights.
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6 Tracking Stock n The dividends of tracking stock are tied to a  particular division, rather than the company  as a whole. n Investors can separately value the divisions. n Its easier to compensate division managers with  the tracking stock. n But tracking stock usually has no voting  rights, and the financial disclosure for the  division is not as regulated as for the  company.
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7 Different Approaches for  Valuing Common Stock n Dividend growth model n Constant growth stocks n Nonconstant growth stocks n Free cash flow method (covered in  Chapter 11) n Using the multiples of comparable firms
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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. P0 = ^ (1 + rs)1 (1 + rs)2 (1 + rs)3 (1 + rs)∞ D1 D2 D3 D∞ + + + … +
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9 For a constant growth stock: D1 = D0(1 + g)1 D2 = D0(1 + g)2 Dt = D0(1 + g)t If g is constant and less than rs, then: P0 = ^ D0(1 + g) rs – g = D1 rs – g
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10 Dividend Growth and PV of  Dividends: P0 = ∑(PV of Dt) $ 0.25 Years (t) Dt = D0(1 + g)t PV of Dt = Dt (1 + r)t If g > r, P0 = ∞ !
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11 What happens if g > rs? P0 = ^ (1 + rs)1 (1 + rs)2 (1 + rs)∞ D0(1 + g)1 D0(1 + g)2 D0(1 + rs)∞ + + … + (1 + g)t (1 + rs)t P0 = ∞ ^ > 1, and So g must be less than rs for the constant growth model to be applicable!! If g > rs, then
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Required rate of return: beta = 1.2,  rRF = 7%, and RPM = 5%.  rs = rRF + (RPM)bFirm = 7% + (5%)(1.2) = 13%. Use the SML to calculate rs:
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FIN 534 chapter 7 info - CHAPTER7 Stocks,StockValuation, and

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