Corporate finance chapter 09 valuation of commen stocks

Chapter 9: Valuation of Common Stocks Objective... Chapter 9 Contents9.1 Reading stock listings 9.2 The discounted dividend model 9.3 Earning and investment opportunity 9.4 A reconsidera

Chapter 9: Valuation of

Common Stocks

Objective

Chapter 9 Contents

9.1 Reading stock listings

9.2 The discounted dividend model

9.3 Earning and investment opportunity

9.4 A reconsideration of the price multiple approach

9.5 Does dividend policy affect shareholder wealth?

Reading Stock Listings

Yr Hi Yr Lo Stock Sym

123 1/8 93 1/8 IBM IBM

Div Yld % PE Vol 100 4.84 4.2 16 14591 Day Hi Day Lo Close Net Chg

Present Value of Dividends

       

         

     

0 1

1

1

1 1

1 1

1

3

4 2

3 1

2 1

1 1

4

4 3

3 2

2 1

1 0

1 1

1 1

1

1 1

1

1 1

1 1

1 1

P

P P

D

k

k

P

D P

k k

D

k

D k

D k

D k

k D

k

D k

D k

D k

D P







































































Expected Rate of Return

expected prices, so

– The expected rate of return in any period

equals the market capitalization rate, k

0 1

D

k  

Rate Relationship

expected dividend yield + the expected capital gain yield is equal to the required rate of return

0

0 1

0

1 0

0 1

1

P

P

P P

D P

P P

D

k      

Price0 Is Discounted Expected (Dividend1 + Price1)

dividend plus the end-of-year price

discounted at the required rate of return

k

P

D P







1

1 1

0

Ease of Use

• Recall from chapter 4 that, for a perpetuity,

the present value is the real value of the

first cash flow divided by the real rate

R

g

D R

D

1

@ nominal

real 0







Putting This Together

    k g

D g

k D

g

k g

D R

g

D p































1 1

1

1 0

1 1

1 1

1 )

1 (

) 1

(

Solving for K

g p

D k

g k

D p











0 1

1 0

G = Capital Gains Yield

0

0 1

0

1 0

1 &

P P

P

P

P P

D k

g p

D k













Earning and Investment

Opportunity

new shares are issues, and no taxes

Dividends = earnings - net new investment

“D = E - I” The formula for valuing stock is





















0

1 1

t t

t t

t

k

I k

E k

D p

Growth Stock

( ))))

* 0.8 (0.4

* 0.8 (0.4

* 0.8 (0.4

* 100 wealth

( ))))

* 60

80

* 0.6 (0.4

* 60

80

* 0.6 (0.4

* 60

80

* 0.6 (0.4

* 100 wealth

















Growth Stock

200

$

0.8 -1

1

* 0.4

* 100

) 0.8

0.8 0.8

(1

* 0.4

* 100 wealth

( ))))

* 0.8 (1

* 0.8 (1

* 0.8 (1

* 0.4

* 100

( ))))

* 0.8 (0.4

* 0.8 (0.4

* 0.8 (0.4

* 100 wealth

3 2











































• Let the

Reinvestment Under Normal

Growth

100

$ 15

0

* 6 0 15

0

6





Retention Ratio Growth Rate Cost of Capital

Illustration: Dividends

Illustration: Dividend Payment

Was 2

Was 10

Illustration: Share Repurchase

Illustration: Share Repurchase

Was 2

Was 10