Professional Documents
Culture Documents
Topic 3 - Stock Valuation
Topic 3 - Stock Valuation
STOCK VALUATION
1. To provide overview of Malaysian stock
market
2. To identify the basic features of preferred
stock
3. To calculate the value of preferred stock
4. To identify the basic features of common
stock
5. To calculate the value of common stock
6. To calculate a stock’s expected rate of return
2
At various stages of a company’s lifecycle, there is need to obtain
capital.
In order to obtain capital, a company may either borrow money
from outside sources (debt financing), sell shares of stock of the
company (equity financing) or use its retained earnings.
However, large volume of capital raise occurs mostly in the
capital market (i.e. debt financing and equity financing).
A Capital market is the platform where the long-term financial
securities are traded between the individuals and the institutions.
In other words, financial institutions sell long-term securities in
capital markets to raise funds.
This market is composed of both primary and secondary markets.
3
Basically, there are four primary methods that companies can use
to raise funds in the capital market as discussed below:
1) Borrowing: Companies raise short term capital by getting loans
from banks or other financial institutions.
issuing company.
5
Bursa Malaysia (formerly known as KLSE) is the
Malaysian stock exchange that provides venue where
trading of stocks and shares can take place.
It is a self-regulatory organization and responsible for
surveillance of marketplace.
It governs and controls its members and member
companies in security dealings.
Bursa Malaysia is divided into two (02) markets where
companies can be listed for security dealings:
1. Main market: It is usually reserved for larger, more
established companies.
2. ACE (Access, Certainty, Efficiency) market: It is
seen as the ideal market for start-ups and new
companies.
6
Preferred stock is a long-term financial instrument that
can be used to raise fund in the capital market.
Solution:
Vps = D/k
= $2.00/0.09 = $22.22
The preferred stockholder’s expected rate of
return can be computed as follows:
kps = D/Vps
kps > k
Solution:
a) kps = D/Vps
12
1) Calculate the expected return of preferred stocks that
a) Pay dividend $1.25 per share & currently sold for
$35.15
b) Currently sold for $48.50 per share and pay
dividend of $4.25 per share.
declaring dividends.
• Dividend payments are not considered a business
8-17
Earnings of common stock:
1. Dividend Income: dividends paid by the
company on a regular basis.
2. Capital gain (or loss) income: income earned by
selling the shares to another people in the market
or selling back to the company.
8-18
18
Common Stock Valuation Models
The following models are frequently used in
Single-holding period
Multiple-holdingperiod
1. Zero-growth/Constant dividend model
2. Constant growth model
3. Non-constant growth/ Supernormal growth
Model
Suppose you are planning to buy the common stock issued
by XYZ company ltd. You expect XYZ’s 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?
Solution:
Suppose you are thinking of purchasing the stock
of Moore Oil, Inc. and you expect it to pay a $2
dividend after one year and you believe that you
can sell the stock for $14 at that time. If you
require a return of 20% on investments of this
kind of security, what is the maximum you
would be willing to pay?
Multiple-holding period
Example:
Max Electronics Ltd. has issued some common stocks
that pay an annual dividend of $0.50 per share. The
company has determined that stocks with similar
characteristics provide a 10 percent rate of return.
Calculate the price of this common stock.
Solution:
Example:
XYZ Inc., just paid a dividend of $0.50 per share of common
stock. It is expected to increase its dividend by 2% per year.
If the market requires a return of 15% on assets of this risk,
how much should be the price of the common stock?
Solution:
Vcs = DO (1+g)/(k-g) = D1/(k-g)
27
2. Header Bhd. paid a RM3.50 dividend last year. At a constant
growth rate of 5 percent, what is the value of the common
stock if the investors require a 20 percent rate of return?
31
Supposed a company is experiencing a supernormal
growth rate in cash dividends of 25% for each of the
next 4 years. After that, the dividend growth rate is
expected to be 5% per year forever. The latest annual
dividend is $0.75. The required return is 22%. How
much does the company’s stock worth?
Solution:
Vcs = D1/(1+ k)1+ D2/(1+ k)2 + D3/(1+ k)3+------+ Dn/(1+ k)n
+ Pn/(1+ k)n
a) Calculation of dividends at the non-constant
growth period (i.e. D1, D2, D3, ------ Dn)
Pn = Dn+1 / (k – g)
P4 = D5/(k – g) = D4 (1 + g)1 / (k – g)
=1.831(1+0.05)1/(0.22–0.05)=$11.312 33
c) Calculation of PV of (a) & (b) to find the value of
the stock (Vcs)
= $8.93
34
By applying the Constant Growth Model, we can compute
required return, dividend yield and capital gains yield
as follows:
Vcs = DO (1+g)/(k-g) = D1/(k-g)
By modifying the above equation, we can calculate the
required return:
k = [DO (1+g)/Vcs] +g = [D1/Vcs] +g
where
D1 = dividend in year 1
D1 Vcs = Market price of the
kcs = ( )+ g stock
Vcs g = growth rate in dividend
Note: When the expected rate of return (kcs) is greater than
the required rate of return (k), i.e.
kcs > k
You should buy the stock
37
Sunrise Corporation’s stock paid a dividend of $4 at the
end of last year and is expected to increase each year at
a 5% growth rate. The stock is currently selling for $75.
Compute the expected rate of return of the stock.
Solution: