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Unformatted text preview: 91CHAPTER 9Stocks and Their Valuation Features of common stockDetermining common stock valuesPreferred stock92Facts about common stockRepresents ownershipOwnership implies controlStockholders elect directorsDirectors elect managementManagement’s goal: Maximize the stock price93Intrinsic Value and Stock PriceOutside investors, corporate insiders, and analysts use a variety of approaches to estimate a stock’s intrinsic value (P).In equilibrium we assume that a stock’s price equals its intrinsic value.Outsiders estimate intrinsic value to help determine which stocks are attractive to buy and/or sell.Stocks with a price below (above) its intrinsic value are undervalued (overvalued).94Determinants of Intrinsic Value and Stock Prices (Figure 11)95Different approaches for estimating the intrinsic value of a common stockDividend growth modelCorporate value modelUsing the multiples of comparable firms96Dividend growth modelValue 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(1D Ps3s32s21s1^97Constant growth stockA stock whose dividends are expected to grow forever at a constant rate, g.D1 = D (1+g)1D2 = D (1+g)2Dt = D (1+g)t If g is constant, the dividend growth formula converges to:g rD g rg)(1D Ps1s^=+=98Future dividends and their present valuestt ) g 1 ( DD+=ttt)r 1 (DPVD+=tPVDP∑=$0.25Years (t)99What happens if g > rs?If g > rs, the constant growth formula leads to a negative stock price, which does not make sense.The constant growth model can only be used if:rs > gg is expected to be constant forever910If rRF = 7%, rM = 12%, and b = 1.2, what is the required rate of return on the firm’s stock?Use the SML to calculate the required rate of return (rs):rs= rRF + (rM – rRF)b= 7% + (12%  7%)1.2= 13%911If D = $2 and g is a constant 6%, find the expected dividend stream for the next 3 years, and their PVs....
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This note was uploaded on 01/23/2012 for the course BUS 361 taught by Professor Staff during the Fall '11 term at University of Michigan.
 Fall '11
 STAFF
 Management, Valuation

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