IFM10 Ch05 Lecture

IFM10 Ch05 Lecture - CHAPTER5 BasicStockValuation 1...

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  1 CHAPTER 5 Basic Stock Valuation
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2 Topics in Chapter Features of common stock Determining common stock values Efficient markets Preferred stock
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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.
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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.
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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.
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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 firm’s managers, key  employees, and, in many situations,  venture capital providers.
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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.
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8 Different Approaches for  Valuing Common Stock Dividend growth model Using the multiples of comparable firms Free cash flow method (covered in  Chapter 11)
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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 0 = ^ (1+r s ) 1 (1+r s ) 2 (1+r s ) 3 (1+r s ) D 1 D 2 D 3 D + + +…+ 
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10 For a constant growth stock: 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 and less than r s , then: P 0  =   ^ D 0 (1+g) r s  - g = D 1 r s  - g
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11 Dividend Growth and PV of  Dividends: P 0  =  (PVof D t ) $ 0.25 Years (t) D t = D 0 (1 + g) t PV of D t = D t (1 + r) t If g > r, P 0 = ∞ !
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12 What happens if g > r s ? P 0  = ^   (1+r s ) 1          (1+r s ) 2               (1+r s ) D 0 (1+g) 1       D 0 (1+g) 2           D 0 (1+r s )   + +…+     (1+g) t       (1+r s ) t If g > r If g > r s s , then , then P 0  =  ^ > 1, and So g must be less than r s  to use the  constant growth model.
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13 Required rate of return: beta = 1.2,  r RF  = 7%, and RPM = 5%.  r s = r RF  + (RP M )b Firm = 7% + (5%) (1.2) = 13%.
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