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Chapter 8. Security Valuation. In general, the intrinsic value of an asset = the present value of the stream of expected cash flows discounted at an appropriate required rate of return. Preferred Stock. A hybrid security : it’s like common stock - no fixed maturity.

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security valuation
Security Valuation
  • In general, the intrinsic value of an asset = the present value of the stream of expected cash flows discounted at an appropriate required rate of return.
preferred stock
Preferred Stock

A hybrid security:

  • it’s like common stock - no fixed maturity.
    • technically, it’s part of equity capital.
  • it’s like debt - preferred dividends are fixed.
    • missing a preferred dividend does not constitute default, but preferred dividends are cumulative.
slide4

Preferred Stock

  • Usually sold for $25, $50, or $100 per share.
  • Dividends are often quoted as a percentage of par.
    • Example: In 1988, Xerox issued $75 million of 8.25% preferred stock at $50 per share.
    • $4.125 is the fixed, annual dividend per share.
common stock
Common Stock
  • is a variable-income security.
    • dividends may be increased or decreased, depending on earnings.
  • represents equity or ownership.
  • includes voting rights.
  • Priority: lower than debt and preferred.
common stock characteristics
Common Stock Characteristics
  • Claim on Income - a stockholder has a claim on the firm’s residual income.
  • Claim on Assets - a stockholder has a residual claim on the firm’s assets in case of liquidation.
  • Preemptive Rights - stockholders may share proportionally in any new stock issues.
  • Voting Rights - right to vote for the firm’s board of directors.
slide7

D1

kcs - g

Vcs =

  • Constant Growth Model
  • Assumes common stock dividends will grow at a constant rate into the future.
  • D1 = the dividend at the end of period 1.
  • kcs= the required return on the common stock.
  • g = the constant, annual dividend growth rate.
example
Example
  • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%?
example1
Example
  • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%?

D0 = $5, so D1 = 5 (1.10) = $5.50

example2

D1 5.50

kcs - g .15 - .10

Vcs = = = $110

Example
  • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%?
expected return on common stock

D

kcs - g

Vcs =

D1

Vcs

k = ( ) + g

Expected Return on Common Stock
  • Just adjust the valuation model
example3

D1

Po

kcs = ( ) + g

kcs = ( ) + .05 = 16.11%

3.00

27

Example
  • We know a stock will pay a $3.00 dividend at time 1, has a price of $27 and an expected growth rate of 5%.
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