Chapter5-IFM10 - 1 CHAPTER 5 Basic Stock Valuation 2 Topics...

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Unformatted text preview: 1 CHAPTER 5 Basic Stock Valuation 2 Topics in Chapter Features of common stock Determining common stock values Efficient markets Preferred stock 3 Common Stock: Owners, Directors, and Managers Represents ownership. Ownership implies control. Stockholders elect directors. Directors hire management. Since managers are agents of shareholders, their goal should be: Maximize stock price. 4 Classified Stock Classified stock has special provisions. Could classify existing stock as founders shares, with voting rights but dividend restrictions. New shares might be called Class A shares, with voting restrictions but full dividend rights. 5 Tracking Stock The dividends of tracking stock are tied to a particular division, rather than the company as a whole. Investors can separately value the divisions. Its easier to compensate division managers with the tracking stock. But tracking stock usually has no voting rights, and the financial disclosure for the division is not as regulated as for the company. 6 Initial Public Offering (IPO) A firm goes public through an IPO when the stock is first offered to the public. Prior to an IPO, shares are typically owned by the firms managers, key employees, and, in many situations, venture capital providers. 7 Seasoned Equity Offering (SEO) A seasoned equity offering occurs when a company with public stock issues additional shares. After an IPO or SEO, the stock trades in the secondary market, such as the NYSE or Nasdaq. 8 Different Approaches for Valuing Common Stock Dividend growth model Using the multiples of comparable firms Free cash flow method (covered in Chapter 11) 9 Stock Value = PV of Dividends What is a constant growth stock? One whose dividends are expected to grow forever at a constant rate, g. P = ^ (1+r s ) 1 (1+r s ) 2 (1+r s ) 3 (1+r s ) D 1 D 2 D 3 D + + ++ 10 For a constant growth stock: D 1 = D (1+g) 1 D 2 = D (1+g) 2 D t = D (1+g) t If g is constant and less than r s , then: P = ^ D (1+g) r s - g = D 1 r s - g 11 Dividend Growth and PV of Dividends: P = (PVof D t ) $ 0.25 Years (t) D t = D (1 + g) t PV of D t = D t (1 + r) t If g > r, P = ! 12 What happens if g > r s ? P = ^ (1+r s ) 1 (1+r s ) 2 (1+r s ) D (1+g) 1 D (1+g) 2 D (1+r s ) + ++ (1+g) t (1+r s ) t If g > r If g > r s s , then , then P = ^ > 1, and So g must be less than r s to use the constant growth model. 13 Required rate of return: beta = 1.2, r...
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This note was uploaded on 03/27/2012 for the course FINA 3320 taught by Professor Picou during the Summer '12 term at Texas A&M University, Corpus Christi.

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Chapter5-IFM10 - 1 CHAPTER 5 Basic Stock Valuation 2 Topics...

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