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Chapter 8

Chapter 8. The Valuation of Stock. Valuation of Preferred Stock. Perpetual preferred Present value of the dividends. Valuation of Perpetual Preferred Stock. Pp = Dp/Kp If Dp = $4, Kp =.08 Pp = $4/.08 = $50. Valuation of Preferred Stock. Finite life preferred

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Chapter 8

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  1. Chapter 8 The Valuation of Stock

  2. Valuation of Preferred Stock • Perpetual preferred • Present value of the dividends

  3. Valuation of Perpetual Preferred Stock • Pp = Dp/Kp • If Dp = $4, Kp =.08 • Pp = $4/.08 = $50

  4. Valuation of Preferred Stock • Finite life preferred • Present value of the dividend and the repayment of the par value

  5. Valuation of Finite Life Preferred Stock • Dp = $4 • S = $100 • N = 30 • Kp = .08 • V = $54.93

  6. Investing in Common Stock • Source of Return • Dividends • Capital gains

  7. Realized Return • Difference in short and long-term capital gains taxation favor capital gains • Transactions costs (e.g., commissions) favor dividend income

  8. Common Stock Valuation • The determination of what a stock is worth; the stock's intrinsic value • If the price exceeds the valuation, buy the stock • If the price is less than the valuation, short the stock

  9. Common Stock Valuation Assuming a Fixed Dividend • V=D/k • Same as perpetual, preferred stock valuation

  10. Common Stock ValuationThe Dividend -- Growth Model • Value depends on the • the required return • the dividend • the growth in the dividend • V = D(1+g)/(k-g)

  11. Dividend - Growth Model Illustration • D = $1 • K = .1 (10%) • g = .06 (6%) • V = $1(1.06)/(.1-.06) = $26.50

  12. Dividend - Growth Model

  13. Dividend - Growth Model • Growth may be uneven • Fundamental concept still applies

  14. Dividend - Growth Model(uneven growth)

  15. The Risk-adjusted Required Return • Adjustment depends on • the risk-free rate (rf) • the return on the market (rm) • the stock's beta

  16. Risk and Required Return

  17. Alternative Valuation Techniques: Use of Ratios • Price-earnings ratios • Value = Earnings x Earnings multiple

  18. Weaknesses in P/E Ratios • Which earnings to use • The appropriate multiplier

  19. Other Ratios • Price / Sales • Price / Book Value

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