CF Winter 2014

Stock Valuation ch 8

Stocks Similar to Bonds  real world  imaginary world

Real World First dividends  regular payments  not a liability of the firm until a dividend declared by Board  can’t go bankrupt for not declaring dividends

Real World dividend taxation not considered a business expense not tax deductible  however corporations  don’t pay taxes on dividends individuals  partially sheltered by dividend tax credit

Real World shareholders  common  preferred

Real World common stockholders  usual rights voting preemptive right share proportionally in  declared dividends  remaining assets during liquidation

Real World preferred stockholders  usually don’t vote preferred stock  stated dividend must be paid before common dividends  can be deferred indefinitely  most are cumulative any missed must be paid before common

Real World a shareholder receives cash in 2 ways  company pays dividends  sell shares

Imaginary World In “theory”

Moore Oil 1 suppose  1 year from now, you think will receive $2 dividend can sell stock for $14 if  you want a 20% return to make something this risky worth investing in What’s the most you would pay?

Moore Oil 1

Moore Oil 2 suppose you think $2.00 dividend in 1 year $2.10 dividend in 2 years can sell the stock in 2 years for $14.70 still want 20% return What’s the most you would pay?

Moore Oil 2

Stock Price only estimate dividends  constant dividend zero growth  constant dividend growth  supernormal growth initially  dividend growth is not consistent eventually  settles down to constant growth You don’t need to estimate the sale price!

Stock Price zero growth dividends  if paid annually

Stock Price zero growth dividends  if paid more frequently suppose you expect  $0.50 dividend every quarter  10% required return  What is rational price?

Stock Price constant growth dividends suppose you expect  $2 annual dividend 1 year from now  5% dividend growth market requires  20% return

Stock Price constant growth dividends suppose  just paid $2 annual dividend you expect  5% dividend growth market requires  20% return

Nonconstant Dividend Growth expected  20% div  in 1 yr  15% div  in 2 yrs  5%  per year from then on  What is current price?

Stock Price Sensitivity to g d 1 =$2 r =20%

Stock Price Sensitivity to r d 1 =$2 g =5%

“Market Requires” similar company  $10.50current stock price  $1.00dividend just paid  5%expected annual div growth  What is required return?