CHAPTER 9 Stocks and Their Valuation. Features of common stock Determining common stock values Preferred stock. Facts about common stock. Represents ownership Ownership implies control Stockholders elect directors Directors elect management. Corporate Organization. 1 3.
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Features of common stock
Determining common stock values
Preferred stock
D1 = D0 (1+g)1
D2 = D1 (1+g)1
D3 = D2 (1+g)1
0 common stock
1
2
3
g = 6%
2.12A
2.247B
2.382C
D0 = 2.00
1.8761
rs = 13%
1.7599
1.6509
If D0 = $2 and g is a constant 6%, find the expected dividend stream for the next 3 years, and their PVs (assume rs = 13%.∞
Div ∞
rs%
A, D1= D0(1+g)1
= 2.00 (1+0.06)
= 2.12
B, D2= D1(1+g)1
= 2.12(1+0.06)
= 2.247
C, D3= D2(1+g)1
= 2.247 (1+0.06)1
= 2.382
D1 = D0 (1+g)1
D2 = D1 (1+g)1
D3 = D2 (1+g)1
A , D0 (1+g)
= 2.0 (1+0.06)
= 2.12
0 common stock
1
2
3
rs = 13%
...
2.00
2.00
2.00
What would the expected price today be, if g = 0?*
* P0 = D
rsg
If g = 0
D1 common stock
Common Stock Valuationg= 30%
∞
g= 6%
D∞
D2
D3
D4
rs%
rs%
rs%
P3; Present value of
all future cash
flows to be
received beyond Yr 3
rs%
P3= D4
rsg
= D3 (1+6%)
rsg
0 common stock
1
2
3
4
rs = 13%
...
g = 30%
g = 30%
g = 30%
g = 6%
D0 = 2.00 2.600 3.380 4.394
4.658
2.301
2.647
3.045
4.658A
=
=
$66.54
46.114B
3

0.13
0.06
54.107 = P0
Valuing common stock with nonconstant growthp: (example 1)rs=13%, n=1
rs=13%, n=2
A= D3 (1+g)
= 4.394(1+6%)
= 4658
rs=13%, n=3
$
rs=13%, n=3
P
^
B: FV=66.54, n=3, I/yr=13%, PV=?
0 common stock
1
2
3
4
rs = 13%
...
g = 0%
g = 0%
g = 0%
g = 6%
D0 = 2.00 2.00 2.00 2.00
2.12
1.77
1.57
1.39
2.12
$
P
=
=
$30.29
20.99
3

0.13
0.06
^
25.72 = P0
Nonconstant growth: (example 2)What if g = 0% for 3 years before longrun growth of 6%?rs=13%, n=1
rs=13%, n=2
rs=13%, n=3
rs=13%, n=3
D1 common stock
Super normal growth (example 3):G= 40% for 5 years before achieving Lr growth of 7%G= 40%
G= 7%
D∞
D2
D3
D4
D5
D6
P5; Present value of
all future cash
flows to be
received beyond Yr 5
P5= D6
rsg
= D5 (1+7%)
rsg
What are the expected dividend yield, capital gains yield, and total return during the first year(assume D1 = 2.12, P1 = 32.10 & P0 = 30.29)?
= D1 / P0 = $2.12 / $30.29 = 7.0%
= (P1 – P0) / P0
= ($32.10  $30.29) / $30.29 = 6.0%
= Dividend Yield + Capital Gains Yield
= 7.0% + 6.0% = 13.0%
If a preferred stock pays an annual dividend of RM5 a share and market interest rate is 10%, what is the preferred stock’s current price?
Vp = D/rp
D= 5
rp=10% , Vp= RM5/ 10%
Vp = RM50
Vp = D / rp
$50 = $5 / rp
rp = $5 / $50
= 0.10 = 10%
^
D∞
D0
D1
D2
One year from now to determine the intrinsic value(p1)
Today
If today: P0 = D1
rs  g
If one year: P1 = D2
from now rs  g
*
*D2= D1 (1+g)
= 2.12 (1+0.06)
= 2.247
*D1= D0 (1+g)
= 2.00 (1+0.06)
= 2.12
FCF= NOPAT – Net capital invest from now(p1)?
FCF = [EBIT(1T) + Depreciation exp]
 [ capital exp + working capital]
0 from now(p1)?
1
2
3
4
r = 10%
...
g = 6%
5 10 20
21.20
4.545
8.264
15.026
21.20
398.197
530 = = TV3
0.10

0.06
416.942
Given the longrun beyond yr 3 is gFCF = 6%, and WACC of 10%, use the corporate value model to find the firm’s intrinsic value.* FCF Y1= 5
Y2= 10
Y3= 20
= $416.94  $40
= $376.94 million
= $376.94 / 10
= $37.69