1. Chapter 8
The Valuation of Stock

2. Valuation of Preferred Stock
Perpetual preferred
Present value of the dividends

3. Valuation of Perpetual Preferred Stock
Pp = Dp/Kp
If Dp = $4, Kp =.08
Pp = $4/.08 = $50

4. Valuation of Preferred Stock
Finite life preferred
Present value of the dividend and the repayment of the par value

5. Valuation of Finite Life Preferred Stock
Dp = $4
S = $100
N = 30
Kp = .08
V = $54.93

6. Investing in Common Stock
Source of Return
Dividends
Capital gains

7. Realized Return
Difference in short and long-term capital gains taxation favor capital gains
Transactions costs (e.g., commissions) favor dividend income

8. Common Stock Valuation
The determination of what a stock is worth; the stock's intrinsic value
If the price exceeds the valuation, buy the stock
If the price is less than the valuation, short the stock

9. Common Stock Valuation Assuming a Fixed Dividend
V=D/k
Same as perpetual, preferred stock valuation

10. Common Stock Valuation The Dividend -- Growth Model
Value depends on the
the required return
the dividend
the growth in the dividend
V = D(1+g)/(k-g)

11. Dividend - Growth Model Illustration
K = .1 (10%)
g = .06 (6%)
V = $1(1.06)/(.1-.06) = $26.50

12. Dividend - Growth Model

13. Dividend - Growth Model
Growth may be uneven
Fundamental concept still applies

14. Dividend - Growth Model (uneven growth)

15. The Risk-adjusted Required Return
Adjustment depends on
the risk-free rate (rf)
the return on the market (rm)
the stock's beta

16. Risk and Required Return

17. Alternative Valuation Techniques: Use of Ratios
Price-earnings ratios
Value = Earnings x Earnings multiple

18. Weaknesses in P/E Ratios
Which earnings to use
The appropriate multiplier

19. Other Ratios
Price / Sales
Price / Book Value