FIN3600_14 - Common Stock Valuation Timothy R. Mayes, Ph.D....

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Unformatted text preview: Common Stock Valuation Timothy R. Mayes, Ph.D. FIN 3600: Chapter 14 What is Value? In general, the value of an asset is the price that a willing and able buyer pays to a willing and able seller Note that if either the buyer or seller is not both willing and able, then an offer does not establish the value of the asset Several Kinds of Value There are several types of value, of which we are concerned with four: Book Value The carrying value on the balance sheet of the firms equity (Total Assets less Total Liabilities) Tangible Book Value Book value minus intangible assets (goodwill, patents, etc) Market Value - The price of an asset as determined in a competitive marketplace Intrinsic Value - The present value of the expected future cash flows discounted at the decision makers required rate of return Determinants of Intrinsic Value There are two primary determinants of the intrinsic value of an asset to an individual: The size and timing of the expected future cash flows. The individuals required rate of return (this is determined by a number of other factors such as risk/return preferences, returns on competing investments, expected inflation, etc.). Note that the intrinsic value of an asset can be, and often is, different for each individual (thats what makes markets work). Common Stock A share of common stock represents an ownership position in the firm. Typically, the owners are entitled to vote on important matters regarding the firm, to vote on the membership of the board of directors, and (often) to receive dividends. In the event of liquidation of the firm, the common shareholders will receive a pro-rata share of the assets remaining after the creditors (including employees) and preferred stockholders have been paid off. If the liquidation is bankruptcy related, the common shareholders typically receive nothing, though it is possible that they may receive some small amount. Common Stock Valuation As with any other security, the first step in valuing common stocks is to determine the expected future cash flows. Finding the present values of these cash flows and adding them together will give us the value: For a stock, there are two cash flows: Future dividend payments The future selling price ( 29 = + = 1 1 t t t CS k CF V Common Stock Valuation: An Example Assume that you are considering the purchase of a stock which will pay dividends of $2 (D 1 ) next year, and $2.16 (D 2 ) the following year. After receiving the second dividend, you plan on selling the stock for $33.33. What is the intrinsic value of this stock if your required return is 15%?...
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FIN3600_14 - Common Stock Valuation Timothy R. Mayes, Ph.D....

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