STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

Chapter 9

Stocks and Their Valuation

Corporate Valuation Model

Other Approaches
Preferred Stock

9-1
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

EXAMPLE

Huang Company's last dividend was

P1.25. The dividend growth rate is
expected to be constant at 15% for 3
years, after which dividends are expected
to grow at a rate of 6% forever. If the firm's
required return (rs) is 11%, what is its
current stock price?

9-2
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

Corporate Valuation Model

• Also called the free cash flow method.

Suggests the value of the entire firm equals
the present value of the firm’s free cash flows.
• Remember, free cash flow is the firm’s after-
tax operating income less the net capital
investment.

FCF  EBIT(1  T) 
Depr. and   Capital 
   NOWC
 amortization expenditures 

9-3
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

Applying the Corporate Valuation Model

• Find the market value (MV) of the firm,

by finding the PV of the firm’s future
FCFs.
• Subtract MV of firm’s debt and preferred
stock to get MV of common stock.
• Divide MV of common stock by the
number of shares outstanding to get
intrinsic stock price (value).

9-4
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

Issues Regarding the Corporate Valuation Model

• Often preferred to the discounted dividend

model, especially when considering number of
firms that don’t pay dividends or when dividends
are hard to forecast.
• Similar to discounted dividend model, assumes
at some point free cash flow will grow at a
constant rate.
• Horizon value (HVN) represents value of firm at
the point that growth becomes constant.

9-5
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

Use the Corporate Valuation Model to Find the

Firm’s Intrinsic Value

Given: Long-Run gFCF = 6% and WACC = 10%

0 r = 10% 1 2 3 4

g = 6%
-5 10 20 21.20
-4.545
8.264
15.026
21.20
398.197 530   HV3
0.10  0.06
416.942

9-6
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

What is the firm’s intrinsic value per share?

The firm has P40 million total in debt and

preferred stock and has 10 million shares of
common stock.
MV of equity  MV of firm  MV of debt and preferred
 $416.94  $40
 $376.94 million

Value per share  MV of equity/# of shares

 $376.94 /10
 $37.69
9-7
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

EXAMPLE
An analyst is trying to estimate the intrinsic value
of the stock of Harkleroad Technologies. The analyst
estimates that Harkleroad’s free cash flow during the
next year will be P25 million.
The analyst also estimates that the company’s free
cash flow will increase at a constant rate of 7 percent
a year and that the company’s WACC is 10 percent.
Harkleroad has P200 million of long-term debt and
preferred stock, and 30 million outstanding shares of
common stock. What is the estimated per-share
price of Harkleroad Technologies’ common stock?
9-8
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

EXAMPLE
Based on the corporate valuation model, Gay
Entertainment's total corporate value is P1,200
million. The company's balance sheet shows P120
million of notes payable, P300 million of long-
term debt, P50 million of preferred stock, P180
million of retained earnings, and P800 million of
total common equity.
If the company has 30 million shares of stock
outstanding, what is the best estimate of its price
per share?
9-9
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

Firm Multiples Method

• Analysts often use the following

multiples to value stocks.
–P/E
–P/CF
–P/Sales

9-10
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

EXAMPLE

During the past few years, Swanson

Company has retained, on the average, 70 percent
of its earnings in the business. The future
retention rate is expected to remain at 70 percent
of earnings, and long-run earnings growth is
expected to be 10 percent. If the risk-free rate,
kRF, is 8 percent, the expected return on the
market, kM, is 12 percent, Swanson’s beta is 2.0,
and the most recent dividend, D0, was P1.50, what
is the most likely market price and P/E ratio
(P0/E1) for Swanson’s stock today?

9-11
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

Preferred Stock

• Hybrid security.
• Like bonds, preferred stockholders
receive a fixed dividend that must be
paid before dividends are paid to
common stockholders.
• However, companies can omit preferred
dividend payments without fear of
pushing the firm into bankruptcy.

9-12
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

If preferred stock with an annual dividend of P5 sells

for P50, what is the preferred stock’s expected return?

D
Vp 
rp
$5
$50 
rp

$5
r̂p 
$50
 0.10  10%
9-13
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

EXAMPLE

The Jones Company has decided to

undertake a large project. Consequently,
there is a need for additional funds. The
financial manager plans to issue preferred
stock with a perpetual annual dividend of
P5 per share and a par value of P30.
If the required return on this stock is
currently 20 percent, what should be the
stock’s market value?
9-14
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

EXAMPLE

A share of preferred stock pays a

quarterly dividend of P2.50. If the
price of this preferred stock is currently
P50, what is the nominal annual rate
of return?

9-15
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
 STK FEATURES INTRINSIC VALUE DISC DIV MODEL CORP VAL MODEL OTHER APPROACHES PREFERRED STK

EVA Approach

EVA = Equity capital(ROE – Cost of equity)

MVEquity = BVEquity + PV of all future EVAs

Value per share = MVEquity/# of shares

9-16
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.