# CHAPTER 8 Stocks and Their Valuation - PowerPoint by G2iv1V

VIEWS: 0 PAGES: 21

• pg 1
```									CHAPTER 9
Stocks and Their Valuation
   Features of common stock
   Stock valuations
   Constant dividend growth model
The behavior of dividends and their PV
The model

Applying the model when g>r, g=0 and g<0

Predict stock price in the future

Dividend yield and capital gain

   Non-constant growth model
   Preferred stock

8-1
   Represents ownership
   Ownership implies control
   Stockholders elect directors
   Directors elect management
   Receives cash flow in the form of
dividend
   Management’s goal: Maximize the
stock price

8-2
Dividend growth model
   Value of a stock is the present value of the
future dividends expected to be generated by
the stock.

^       D1        D2            D3                  D
P0                                     ...            
(1  rs ) (1  rs )
1          2
(1  rs ) 3
(1  rs )

8-3
Constant growth stock
   A stock whose dividends are expected to
grow forever at a constant rate, g.

D1 = D0 (1+g)1
D2 = D0 (1+g)2
Dt = D0 (1+g)t
   Will the dividend becomes larger and larger?
   Will the present value of dividend grow?
   Suppose D0 is \$2, dividend growth rate is
5%, and discount rate is 10%, what is D50
and PV(D50)?
   Graph representation                      8-4
Future dividends and their
present values
t
\$           D t  D0 ( 1  g )

Dt
\$1             PVD t 
( 1  r )t

P0   PVD t

1                                     Years (t)
8-5
Constant growth stock

   If g is constant, the dividend growth formula
converges to:
^    D 0 (1  g) D1
P0             
rs - g    rs - g

8-6
What happens if g > rs?
   If g > rs, the constant growth formula
leads to a negative stock price, which
does not make sense.
   The constant growth model can only be
used if:
   rs > g
   g is expected to be constant forever

8-7
If rRF = 7%, rM = 12%, and β = 1.2,
what is the required rate of return on
the firm’s stock?
   Use the SML to calculate the required
rate of return (ks):
rs = rRF + (rM – rRF)β
= 7% + (12% - 7%)1.2
= 13%
   D0 = \$2 and g is a constant 6%,

8-8
What is the stock’s market value?
   Using the constant growth model:

D1      \$2.12
P0        
rs - g 0.13 - 0.06
\$2.12

0.07
 \$30.29

8-9
What would the expected price
today be, if g = -5%?, if g=0?
   When g=-5% D1=1.9, P=1.9/(13%+5%)=10.56
   When g=0, The dividend stream would be a
perpetuity.
0               1        2          3
rs = 13%
...
2.00    2.00       2.00
^    PMT \$2.00
P0            \$15.38
r   0.13

8-10
Computing other variables
^      D 0 (1  g) D1
P0               
rs - g    rs - g
   Computing Ks
   Computing D
   Computing g

8-11
What is the expected market price
of the stock, one year from now?
   D1 will have been paid out already. So,
P1 is the present value (as of year 1) of
D2, D3, D4, etc.
^    D2      \$2.247
P1        
rs - g 0.13 - 0.06
 \$32.10

8-12
Future stock price
   What is the expected market price of the stock   P2,
two years from now?
^     D3      \$2.382
P2        
rs - g 0.13 - 0.06
 \$34.03
   What is the expected market price of the stock   Pn, n
years from now?
^   D0 (1 g)n 1 Dn 1
Pn               
rs - g     rs - g

8-13
The growth rate of stock price
   What is the % change of stock price from   P0   to   P1
and from   P1   to   P2
   What is the % change of stock price from   Pn   to
Pn+1
   What is the expected market price of the stock   P2,
two years from now?
   P2 =P1 *(1+g)= P0 *(1+g)2

8-14
What is the expected dividend yield,
capital gains yield, and total return
during the first year?
   Dividend yield
= D1 / P0 = \$2.12 / \$30.29 = 7.0%
   Capital gains yield
= (P1 – P0) / P0
= (\$32.10 - \$30.29) / \$30.29 = 6.0%
   Total return (rs)
= Dividend Yield + Capital Gains Yield
= 7.0% + 6.0% = 13.0%

8-15
Dividend Yield and Capital
Gain
   P0=D1/(r-g)
   k=(D1/P0)+g
   Total return=dividend yield + Capital
gain
   g is capital gain for constant growth
stock

8-16
Supernormal growth:
What if g = 30% for 3 years before
achieving long-run growth of 6%?
   Can no longer use just the constant growth
model to find stock value.
   However, the growth does become
constant after 3 years.

8-17
Valuing common stock with
nonconstant growth

0 r = 13% 1               2              3              4
s
...
g = 30%       g = 30%       g = 30%        g = 6%
D0 = 2.00        2.600         3.380         4.394         4.658
2.301
2.647
3.045
4.658
46.114                          \$
P3                      \$66.54
^                        0.13 - 0.06
54.107    = P0
8-18
Nonconstant growth:
What if g = 0% for 3 years before long-
run growth of 6%?

0 r = 13% 1                2              3               4
s
...
g = 0%          g = 0%       g = 0%          g = 6%
D0 = 2.00           2.00        2.00          2.00            2.12
1.77
1.57
1.39
2.12
20.99                            \$
P3                       \$30.29
^                          0.13 - 0.06
25.72     = P0
8-19
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.
8-20
If preferred stock with an annual
dividend of \$5 sells for \$50, what is the
preferred stock’s expected return?

Vp = D / rp
\$50 = \$5 / rp

rp = \$5 / \$50
= 0.10 = 10%

8-21

```
To top