STOCK VALUATION

Value of a share of CS = PV of future cash flows

= PV dividends + PV(future price)

Rights of the common stockholder:

1. Voting - elect the board of directors (proxy)

2. Pre-emptive right

3. Liquidation value

4. Dividends

Some firms may have different classes of common stock

A shares
B shares

Preferred stock is considered a “hybrid” security with some

of the following features:

1. _________-all dividends in arrears must be paid before

any common stock dividend can be paid
2. __________-the preferred stockholder may share in an
extra or bonus dividend with the common stockholder
3. _______-the firm can notify the stockholder and force
them to sell back the stock (retire the stock)
4. __________-the preferred stockholder may convert
their preferred stock into a specified number of common
stock shares
5. Terms-the dividend is usually fixed and based on par

Long-term securities (stocks and bonds) are traded in the

Capital Markets

Short-term securities (T-bills and commercial paper) are

traded in the Money Market

Primary market vs secondary market

Preferred Stock Valuation:

Vps = dividend
required return

What is the value of an $80 par value PS with a 9% coupon (dividend)

if investors only require an 8.5% return?

Vps =

What is an investor’s required return if a PS can be purchased for $40

and it pays a dividend of $3.20?

Rps = dividend
stock price

Common Stock Valuation:

1. Book Value

2. Liquidation Value

3. Market Value = selling price

4. P/E Multiple: selling price = P/E X EPS

5. Zero Growth = dividend

required return

6. Normal Growth Rate Model

Constant Growth Rate Model
Gordon Model

Vcs = D1
Rcs – g
 D1 = next year’s dividend
Rcs = required return
g = growth rate of earnings and/or dividends

What is the value of a share of CS that has a $2.40 projected

dividend (D1), a growth rate of 7% (g) when investors’ have
a required return of 12% (Rcs)?

Vcs = 2.40 = $48.00

.12 - .07

What would happen to the stock price if investor’s required a

higher return of 15%? (Why would they need a higher return?)

Vcs = 2.40 = $30.00

.15 - .07

(as risk increases, Rcs increases resulting in a lower stock price)

What is the value of CS with a current (or recently paid) dividend?

Of $3.00, a growth rate of 10% when investors require a return of
15%?

Vcs = 3.00(1 + .10) = D1 = 3.30 = $66.00

.15 - .10

What is the required return for CS that has a current dividend of

$3.00, a projected growth rate of 15% that is selling for $70?

Rcs = D1 + g
Price

= 3.45 +.15
70

= .199 or 19.9%
What is the required return if the stock is selling for $55 a share?

Rcs = 3.45 + .15

55

= .213 or 21.3%

7. Variable Growth Rate Model

Vcs = PV dividends + PV future stock price

What is the following stock worth to an investor?

Current dividend is $2.55

Projected 3 year super normal growth rate of 25%
Growth rate after year 3 to fall and remain constant at 10%
Required return of 15%

Step 1: PV dividends during the initial growth period

t Do FVIF(D1) Dt PVIF(D3) PVdiv

1 2.55 1.250 3.19 .870 $2.78
2 2.55 1.562 3.98 .756 $3.01
3 2.55 1.953 4.98 .658 $3.28
$9.07

Step 2: FV of the stock after the initial growth period

Dividend in year 4 = 4.98 (1 + .10) = $5.48

Vcs = $5.48 = $109.60

.15-.10

Step 3: PV of the future stock price

$109.60(PVIF 15%, 3 years = .658) = $72.12

 Step 4: Current value of the common stock

$9.07 + $72.12 = $81.19

What would an inventor be willing to pay for the following stock?

Current dividend is $1.40

Projected 3 year super normal growth rate of 20%
Growth rate after year 3 expected to fall and remain constant at 12%
Investors’ required return is 14%

1)
t Do FVIF(D1) Dt PVIF(D3) PVdiv
1 1.40 1.200 1.68 .877 $1.47
2 1.40 1.440 2.02 .769 $1.55
3 1.40 1.728 2.42 .675 $1.63
$4.65

2) 2.42 (1+.12) = $2.71

Vcs = $2.71 = $135.50

.14-.12

3) $135.50(PVIF 14%, 3 years = .675) = $91.46

4) $4.65 + $91.46 = 96.11