Valuation

This chapter is concerned with the valuation

of the firm’s long-term securities –
◼ Bonds,

◼ Preferred stock,

◼ Common stock.

Ms. Aisha Riaz

University of Okara.
Preferred Stock
◼ Preferred stock is a hybrid security that has combine
features of equity and debts.
◼ Like bonds, preferred stockholders receive a fixed dividend.
However, companies can omit preferred dividend payments
without fear of pushing the firm into bankruptcy.

◼ Timing: Preferred stock has no maturity date.

◼ Cash Flow: Preferred stock promises a fixed periodic
dividend, which is stated either as a percentage or as a
dollar amount.
◼ Risk: Because preferred stockholders have a fixed claim on
the firm’s income that takes precedence over the claim
of common stockholders, so preferred stockholders are
exposed to less risk. However creditors has precedence
7-2
over the claim of preferred stock.
 Features of Preferred Stock
1. Par-value preferred stock: has a stated face value, and its annual
dividend is specified as a percentage of this value.
2. No-par preferred stock: has no stated face value, but its annual
dividend is stated in dollars.
3. Cumulative preferred stock: Preferred stock which has restriction
to pay all unpaid dividends in arrears, along with the current
dividend, before dividends can be paid to common stockholders.
4. Non-cumulative preferred stock: Preferred stock for which
unpaid dividends do not accumulate.
5. Callable preferred stock: Callable preferred stock allows the issuer
to retire the shares within a certain period of time and at a specified
price.
6. Convertible preferred stock: Convertible preferred stock that
allows holders to change each share into a stated number of 7-3 shares
of common stock.
Valuation of Preferred stock
◼ Preferred stock has no maturity date, so it pays fixed periodic
dividend in the form for percentage of fixed amount.
the present value of an
✓ Value of preferred stock = infinite stream of regular
divided payments.
DP DP D
VP = + +  + Ordinary Annuity
(1 + k P )1 (1 + k P ) 2 (1 + k P ) 

DP
VP = 
t =1 (1 + k P )t
DP
VP =
kP
◼ Where
◼ Vp= Present value (Intrinsic) of preferred stock
◼ Dp = fixed divided payment
◼ kd = required return on the stock 7-4
◼ t = Infinite
Question 5: Stock PS has an 8%, $100 par value issue outstanding. The
appropriate discount rate is 10%. What is the value of the preferred stock?
Par value = &100
Annual coupon rate = 8% =0.08
Required rate of return = kp = 10%. =0.1
Divided per share = Dp = $100 (0.08) = $8.00
Value of Preferred share = Vp = Dp / kp =?
= Vp = $8 / 0.1 = $80.

This $80 is the maximum amount that you would be willing to pay for this preferred
share. If the market price is greater than this amount, however, you should not buy it.

Practice 5.1: Suppose Margana Cipher Corporation had a 9 percent, $100 par-value
preferred stock issue outstanding and your required return was 14 percent on this
investment, what would be the value of this security?
Answer: $64.29

Practice 5.2: A preferred stock paying a $5 stated annual dividend and having a
required return of 13 percent. What would have a value of per share?
Answer:7-5
$38.46