? 2002,Prentice Hall,Inc,
Ch,8,Stock 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
A hybrid security,
? it’s like common stock - no fixed maturity,
Preferred Stock
A hybrid security,
? it’s like common stock - no fixed maturity,
– technically,it’s part of equity capital,
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,
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,
? Usually sold for $25,$50,or $100 per
share,
? Dividends are fixed either as a dollar
amount or as a percentage of par value,
? 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,
Preferred Stock
? Firms may have multiple classes of
preferreds,each with different features,
? Priority,lower than debt,higher than
common stock,
? Cumulative feature,all past unpaid
preferred stock dividends must be paid
before any common stock dividends are
declared,
Preferred Stock Features
? Protective provisions are common,
? Convertibility,many preferreds are
convertible into common shares,
? Adjustable rate preferreds have
dividends tied to interest rates,
? Participation,some (very few)
preferreds have dividends tied to the
firm’s earnings,
Preferred Stock Features
? PIK Preferred,Pay-in-kind preferred
stocks pay additional preferred shares
to investors rather than cash dividends,
? Retirement,Most preferreds are
callable,and many include a sinking
fund provision to set cash aside for the
purpose of retiring preferred shares,
Preferred Stock Features
Preferred Stock Valuation
? A preferred stock can usually be
valued like a perpetuity,
Preferred Stock Valuation
? A preferred stock can usually be
valued like a perpetuity,
V = D k ps
ps
Example,
? Xerox preferred pays an 8.25%
dividend on a $50 par value,
? Suppose our required rate of
return on Xerox preferred is 9.5%,
Example,
? Xerox preferred pays an 8.25%
dividend on a $50 par value,
? Suppose our required rate of
return on Xerox preferred is 9.5%,
V ps = 4.125,095 =
Example,
? Xerox preferred pays an 8.25%
dividend on a $50 par value,
? Suppose our required rate of
return on Xerox preferred is 9.5%,
V ps = 4.125,095 = $43.42
Expected Rate of Return
on Preferred
? Just adjust the valuation model,
Expected Rate of Return
on Preferred
? Just adjust the valuation model,
D
Po kps =
Example
? If we know the preferred stock price
is $40,and the preferred dividend is
$4.125,the expected return is,
Example
? If we know the preferred stock price
is $40,and the preferred dividend is
$4.125,the expected return is,
D
Po kps = = =
4.125
40
Example
? If we know the preferred stock price
is $40,and the preferred dividend is
$4.125,the expected return is,
D
Po kps = = =,1031
4.125
40
The Financial Pages,
Preferred Stocks
52 weeks Yld Vol
Hi Lo Sym Div % PE 100s Close
2788 2506 GenMotor pfG 2.28 8.9 … 86 25 53
? Dividend,$2.28 on $25 par value
= 9.12% dividend rate,
? Expected return,2.28 / 25.53 = 8.9%,
Common Stock
? is a variable-income security,
– dividends may be increased or decreased,
depending on earnings,
? represents equity or ownership,
? includes voting rights,
? Limited liability,liability is limited to
amount of owners’ investment,
? Priority,lower than debt and preferred,
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,
? You expect XYZ stock to pay a $5.50
dividend at the end of the year,The stock
price is expected to be $120 at that time,
? If you require a 15% rate of return,what
would you pay for the stock now?
Common Stock Valuation
(Single Holding Period)
? You expect XYZ stock to pay a $5.50
dividend at the end of the year,The stock
price is expected to be $120 at that time,
? If you require a 15% rate of return,what
would you pay for the stock now?
Common Stock Valuation
(Single Holding Period)
0 1
5.50 + 120
Common Stock Valuation
(Single Holding Period)
Solution,
Vcs = (5.50/1.15) + (120/1.15)
= 4.783 + 104.348
= $109.13
Common Stock Valuation
(Single Holding Period)
Financial Calculator solution,
P/Y =1,I = 15,n=1,FV= 125.50
solve,PV = -109.13
or,
P/Y =1,I = 15,n=1,FV= 120,
PMT = 5.50
solve,PV = -109.13
The Financial Pages,
Common Stocks
52 weeks Yld Vol Net
Hi Lo Sym Div % PE 100s Hi Lo Close Chg
135 80 IBM,52,5 21 142349 99 93 9496 -343
82 18 CiscoSys … 47 1189057 21 19 20 25 -113
Common Stock Valuation
(Multiple Holding Periods)
? Constant Growth Model
? Assumes common stock dividends
will grow at a constant rate into
the future,
Common Stock Valuation
(Multiple Holding Periods)
? Constant Growth Model
? Assumes common stock dividends
will grow at a constant rate into
the future,
Vcs = D1 kcs - g
? Constant Growth Model
? Assumes common stock dividends will grow
at a constant rate into the future,
? Constant Growth Model
? Assumes common stock dividends will grow
at a constant rate into the future,
Vcs =
D1
kcs - g
? 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,
Vcs = D1 kcs - g
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%?
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
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%?
Vcs =
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%?
Vcs = = D1 k
cs - g
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%?
Vcs = = = D1 5.50 k
cs - g,15 -,10
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%?
Vcs = = = $110 D1 5.50 k
cs - g,15 -,10
Expected Return on
Common Stock
? Just adjust the valuation model
Expected Return on
Common Stock
? Just adjust the valuation model
Vcs = D k
cs - g
Expected Return on
Common Stock
? Just adjust the valuation model
Vcs = D k
cs - g
k = ( ) + g D1 V
cs
Expected Return on
Common Stock
? Just adjust the valuation model
Vcs = D k
cs - g
k = ( ) + g D1 P
o
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%,
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%,
kcs = ( ) + g D1 P
o
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%,
kcs = ( ) + g D1 P
o
kcs = ( ) +,05 = 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%,
kcs = ( ) + g D1 P
o
kcs = ( ) +,05 = 16.11% 3.00 27