Chapter 6 - Stock Valuation

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Common Stock Valuation
(Single Holding Period)
You expect XYZ 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?
kps
D = Po
4.125 = = 40
Example
If we know the preferred stock price is
$40, and the preferred dividend is $4.125, the expected return is:
kps
D = Po
4.125 = = .1031 40
? 0
5.50 + 120 1
Common Stock Valuation
(Single Holding Period)
Solution:
Vcs = (5.50/1.15) + (120/1.15) = 4.783 + 104.348
= $109.13
Common Stock Valuation
Xerox preferred pays an 8.25%
dividend on a $50 par value. Suppose our required rate of return on Xerox preferred is 9.5%.
Vps =
4.125 .095
=
Example:
It’s like debt - preferred dividends are
fixed.
Preferred Stock
A hybrid security: It’s like common stock - no fixed maturity.
Technically, it’s part of equity capital.
Common Stock Valuation
(Single Holding Period)
You expect XYZ 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?
Technically, it’s part of equity capital.
Preferred Stock
A hybrid security: It’s like common stock - no fixed maturity.
Technically, it’s part of equity capital.
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Chapter 6 - Stock Valuation
Security Valuation
In general, the intrinsic value of
an asset = the present value of the stream of expected cash flows discounted at an appropriate required rate of return.
Preferred Stock
A hybrid security: It’s like common stock - no fixed maturity.
Preferred Stock
A hybrid security: It’s like common stock - no fixed maturity.
Xerox preferred pays an 8.25%
dividend on a $50 par value. Suppose our required rate of return on Xerox preferred is 9.5%.
Vps =
4.125 .095
=
$43.42
Expected Rate of Return on Preferred
Usually sold for $25, $50, or $100 per
share. Dividends are fixed either as a dollar amount or as a percentage of par value. Example: In 1988, Xerox issued $75 million of 8.25% preferred stock at $50 per share.
The Financial Pages:
Common Stocks
52 weeks Yld Vol Net Hi Lo Sym Div % PE 100s Hi Lo Close Chg 135 80 IBM .52 .5 21 142349 99 93 9496 -343
82 18 CiscoSys … 47 1189057 21 19 2025 -113
Preferred Stock Valuation
A preferred stock can usually be
valued like a perpetuity:
Preferred Stock Valuation
A preferred stock can usually be
valued like a perpetuity:
Vps =
D k ps
Example:
Xerox preferred pays an 8.25%
dividend on a $50 par value. Suppose our required rate of return on Xerox preferred is 9.5%.
Example:
Preferred Stock Features
Protective provisions are common. Convertibility: many preferreds are
convertible into common shares. Adjustable rate preferreds have dividends tied to interest rates. Participation: some (very few) preferreds have dividends tied to the firm’s earnings.
Preferred Stock Features
PIK Preferred: Pay-in-kind preferred
stocks pay additional preferred shares to investors rather than cash dividends. Retirement: Most preferreds are callable, and many include a sinking fund provision to set cash aside for the purpose of retiring preferred shares.
Just adjust the valuation model:
Expected Rate of Return on Pref valuation model:
kps =
D Po
Example
If we know the preferred stock price is
(Single Holding Period)
Financial Calculator solution:
P/Y =1, I = 15, n=1, FV= 125.50
solve: PV = -109.13 or: P/Y =1, I = 15, n=1, FV= 120, PMT = 5.50 solve: PV = -109.13
Represents equity or ownership. Includes voting rights. Limited liability: liability is limited to
amount of owners’ investment. Priority: lower than debt and preferred.
$4.125 is the fixed, annual dividend per share.
Preferred Stock Features
Firms may have multiple classes of
preferreds, each with different features. Priority: lower than debt, higher than common stock. Cumulative feature: all past unpaid preferred stock dividends must be paid before any common stock dividends are declared.
Common Stock Characteristics
Claim on Income - a stockholder has a
claim on the firm’s residual income. Claim on Assets - a stockholder has a residual claim on the firm’s assets in case of liquidation. Preemptive Rights - stockholders may share proportionally in any new stock issues. Voting Rights - right to vote for the firm’s board of directors.
= 9.12% dividend rate.
Expected return: 2.28 / 25.53 = 8.9%.
Common Stock
Is a variable-income security.
Dividends may be increased or decreased, depending on earnings.
$40, and the preferred dividend is $4.125, the expected return is:
Example
If we know the preferred stock price is
$40, and the preferred dividend is $4.125, the expected return is:
It’s like debt - preferred dividends are
fixed.
Missing a preferred dividend does not constitute default, but preferred dividends are cumulative.
Preferred Stock
The Financial Pages:
Preferred Stocks
52 weeks Yld Hi Lo Sym Div % 2788 2506 GenMotor pfG 2.28 8.9 Vol PE 100s Close … 86 25 53
Dividend: $2.28 on $25 par value
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