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Some firms have both common and preferred shares. Common stockholders are residual claimants on
corporate income and assets, whereas preferred shareholders are entitled only to a fixed dividend (with
priority over common stockholders). In this case the preferred stocks can be valued as a perpetuity paying
a constant dividend forever. (18) P0 Div
r The perpetuity formula can also be applied to value firms in general if we assume no growth and that all
earnings are paid out to shareholders. (19) P0 Div1
r If a firm elects to pay a lower dividend, and reinvest the funds, the share price may increase because future
dividends may be higher.
Growth can be derived from applying the return on equity to the percentage of earnings ploughed back
(20) g = return on equity · plough back ratio Download free ebooks at bookboon.com
22 Corporate Finance Present value and opportunity cost of capital Where the plough back ratio is the fraction of earnings retained by the firm. Note that the plough back
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- Spring '12