CFFM6_ch 09_slides

# CFFM6_ch 09_slides - Chapter9 PreferredStock 91...

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Stocks and Their Valuation Chapter 9 Features of Common Stock Determining Common Stock Values Preferred Stock 9-1

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Facts about Common Stock Represents ownership Ownership implies control Stockholders elect directors Directors elect management Management’s goal: Maximize the stock price 9-2
Intrinsic Value and Stock Price Outside investors, corporate insiders, and  analysts use a variety of approaches to  estimate a stock’s intrinsic value (P 0 ). 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 ). 9-3

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Different Approaches for Estimating the  Intrinsic Value of a Common Stock Discounted dividend model Corporate valuation model Using the multiples of comparable firms 9-4
Discounted Dividend Model Value of a stock is the present value of the  future dividends expected to be generated by  the stock. + + + + + + + + = ) r (1 D     ...     ) r (1 D     ) r (1 D     ) r (1 D     P ˆ s 3 s 3 2 s 2 1 s 1 0 9-5

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Constant Growth Stock g r D     g r g) (1 D     P ˆ s 1 s 0 0 - = - + = 9-6 A stock whose dividends are expected to  grow forever at a constant rate, g. D 1  = D 0 (1 + g) 1 D 2  = D 0 (1 + g) 2 D t  = D 0 (1 + g) t   If g is constant, the discounted dividend  formula converges to:
What happens if g > r s ? If g > r s , the constant growth formula leads to  a negative stock price, which does not make  sense. The constant growth model can only be used  if: r s  > g. g is expected to be constant forever. 9-7

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Rate of Return (r s ) If r RF  = 7%, r M  = 12%, and b = 1.2, what is the  required rate of return on the firm’s stock? r
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CFFM6_ch 09_slides - Chapter9 PreferredStock 91...

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