This document discusses various models for valuing common stocks, including:
1. Dividend discount models that value stocks based on the present value of expected future dividends, assuming either a constant growth rate or shifting growth rates over time.
2. Price/earnings ratio models that relate a stock's price to its earnings, taking into account factors like required rates of return and expected growth rates.
3. Free cash flow to equity models that value stocks based on the present value of expected future free cash flows to equity holders after meeting all other financial obligations.
by- g 6 envensebles
For downloading this contact- bikashkumar.bk100@gmail.com
Prepared by Students of University of Rajshahi
Dip Murmu & Md. Abadullah Miah
Neamur Rabbi & Md. Azad Khan
Anik Costa & Tanvir Hasan Plabon
Tarikul Islam Tarif
Md. Jakir Hossain Khan & Dilruba Jahan
Shanjida Afrin & Md. Rajib
This document provides an overview of equity valuation models, including the constant dividend growth model. It discusses key concepts such as intrinsic value, market price, expected returns and growth rates. Several examples are provided to demonstrate how to apply the constant dividend growth model to calculate the intrinsic value of stocks given information about dividends, growth rates, and required rates of return. The document also discusses how growth opportunities affect stock prices and the relationship between return on equity, reinvestment rates, and growth rates.
This document discusses various theories of dividend decision-making. It introduces Walter's model, Gordon's model, and the Miller-Modigliani theorem. Walter's model values a stock based on the present value of its dividend stream and retained earnings. Gordon's model similarly values a stock based on its dividend yield and growth rate. The Miller-Modigliani theorem argues that the value of a firm is determined solely by its earnings regardless of its dividend payout ratio.
The document discusses various models for valuing common stocks, including the dividend discount model, constant growth model, and free cash flow to equity valuation model. It explains that common stock valuation involves estimating future cash flows from dividends and sale proceeds, determining appropriate discount rates, and calculating the present value of the expected cash flows. The length of the high-growth period, growth rates, and required rates of return are key inputs to these valuation techniques.
The document discusses various models for valuing common stocks, including the dividend discount model, constant growth model, and free cash flow to equity valuation model. It explains that common stock valuation involves estimating future cash flows from dividends and sale proceeds, determining appropriate discount rates, and calculating the present value of the expected cash flows. Parameters like growth rates, holding periods, and terminal values must be estimated to apply these valuation techniques.
This is the fourth presentation for the University of New England Graduate School of Business unit, GSB711 - Managerial Finance. This presentation looks at returns on different types of investment.
This document discusses how to value bonds and stocks. It defines bonds, how bond values are determined from present values of coupon payments and par value, and how bond prices are inversely related to market interest rates. It also discusses how to value common stocks based on present values of expected future dividends and capital gains, using dividend discount models for stocks with zero, constant, or differential growth. Growth opportunities can increase stock value if positive NPV projects are undertaken. The price-earnings ratio is also discussed.
This document discusses how to value bonds and stocks. It defines bonds, how bond values are determined from present values of coupon payments and par value, and how bond prices are inversely related to market interest rates. It also discusses how to value common stocks based on present values of expected future dividends and capital gains, using dividend discount models for stocks with zero, constant, or differential growth. Growth opportunities can increase stock value if positive NPV projects are undertaken. The price-earnings ratio is also discussed.
by- g 6 envensebles
For downloading this contact- bikashkumar.bk100@gmail.com
Prepared by Students of University of Rajshahi
Dip Murmu & Md. Abadullah Miah
Neamur Rabbi & Md. Azad Khan
Anik Costa & Tanvir Hasan Plabon
Tarikul Islam Tarif
Md. Jakir Hossain Khan & Dilruba Jahan
Shanjida Afrin & Md. Rajib
This document provides an overview of equity valuation models, including the constant dividend growth model. It discusses key concepts such as intrinsic value, market price, expected returns and growth rates. Several examples are provided to demonstrate how to apply the constant dividend growth model to calculate the intrinsic value of stocks given information about dividends, growth rates, and required rates of return. The document also discusses how growth opportunities affect stock prices and the relationship between return on equity, reinvestment rates, and growth rates.
This document discusses various theories of dividend decision-making. It introduces Walter's model, Gordon's model, and the Miller-Modigliani theorem. Walter's model values a stock based on the present value of its dividend stream and retained earnings. Gordon's model similarly values a stock based on its dividend yield and growth rate. The Miller-Modigliani theorem argues that the value of a firm is determined solely by its earnings regardless of its dividend payout ratio.
The document discusses various models for valuing common stocks, including the dividend discount model, constant growth model, and free cash flow to equity valuation model. It explains that common stock valuation involves estimating future cash flows from dividends and sale proceeds, determining appropriate discount rates, and calculating the present value of the expected cash flows. The length of the high-growth period, growth rates, and required rates of return are key inputs to these valuation techniques.
The document discusses various models for valuing common stocks, including the dividend discount model, constant growth model, and free cash flow to equity valuation model. It explains that common stock valuation involves estimating future cash flows from dividends and sale proceeds, determining appropriate discount rates, and calculating the present value of the expected cash flows. Parameters like growth rates, holding periods, and terminal values must be estimated to apply these valuation techniques.
This is the fourth presentation for the University of New England Graduate School of Business unit, GSB711 - Managerial Finance. This presentation looks at returns on different types of investment.
This document discusses how to value bonds and stocks. It defines bonds, how bond values are determined from present values of coupon payments and par value, and how bond prices are inversely related to market interest rates. It also discusses how to value common stocks based on present values of expected future dividends and capital gains, using dividend discount models for stocks with zero, constant, or differential growth. Growth opportunities can increase stock value if positive NPV projects are undertaken. The price-earnings ratio is also discussed.
This document discusses how to value bonds and stocks. It defines bonds, how bond values are determined from present values of coupon payments and par value, and how bond prices are inversely related to market interest rates. It also discusses how to value common stocks based on present values of expected future dividends and capital gains, using dividend discount models for stocks with zero, constant, or differential growth. Growth opportunities can increase stock value if positive NPV projects are undertaken. The price-earnings ratio is also discussed.
This document provides an overview of different valuation methods including discounted cash flow valuation using free cash flow to equity, free cash flow to the firm, and dividend discount models. It also covers residual income valuation and relative valuation. Details are given on the steps and considerations for each method, including projecting cash flows, estimating the terminal value, and determining appropriate discount rates. Guidelines are provided on when each valuation approach is most applicable.
This document discusses stock valuation using the Gordon Growth Model. It begins by introducing the Gordon Growth Model, which values a stock based on discounting the dividends that are distributed to shareholders. It then provides assumptions of the model, such as the business being stable and experiencing steady growth. The document also discusses estimating free cash flow to equity and financial leverage. It provides an example analysis of stock valuation for Consolidated Edison using the Gordon Growth Model.
Dividend Policy resolves two questions:
Question 1: Does dividend policy affect firm value?
Question 2: If so, What is the optimal level of distribution ratio i.e., % Net Income to be distributed as dividend (Payout ratio). These issues are discussed under Irrelevance Theories (Modigliani and Miller’s Model) and
Relevance Theories (Walter’s Model , Gordon’s Model)
The document discusses dividend decision and dividend policy. It defines dividends as profits distributed to shareholders. Dividend decision is made by company directors and impacts capital structure, stock price, and shareholder taxation. Determinants of dividend policy include payout ratio, stability, legal constraints, owners' needs, and capital market factors. Common dividend policies are regular, stable, and irregular. Dividends can be interim, proposed, final, unclaimed, etc. Various theories on the relationship between dividends and firm value are discussed, including whether dividends are relevant or irrelevant to value. Models by Walter, Gordon, and Miller-Modigliani are summarized.
The document outlines topics related to stock valuation including: differentiating between debt and equity; features of common and preferred stock; the process of issuing common stock; market efficiency and basic stock valuation models; free cash flow valuation and other approaches like book value and P/E multiples; and the relationships between financial decisions, risk, return, and firm value. The document contains sections on these topics and will provide information to understand concepts of stock valuation.
This document discusses various methods for valuing stocks, including discounted cash flow models like the dividend discount model and free cash flow models. It compares the cash flows to bond investors versus equity investors. Key valuation methods covered include relative valuation using price-earnings ratios and multiples of book value per share. The document also provides examples of calculating stock values using these various approaches.
The document discusses various methods for valuing common stock, including calculating the present value of future dividends using the dividend discount model. It outlines three cases for the pattern of future dividends: zero growth, constant growth, and non-constant growth. Key valuation formulas and an example are provided. Additional stock features and components of the required return such as the dividend yield and capital gains yield are also examined.
The document discusses several theories on corporate dividend policies:
1. Dividend relevance theories argue that a firm's dividend policy impacts its value. Walter's and Gordon's models show how value is determined based on factors like earnings, dividends, growth rates, and costs of capital.
2. Dividend irrelevance theories, proposed by Modigliani and Miller, state that a firm's value depends only on its investment policy, not its dividend policy.
3. The bird-in-hand theory suggests that even in situations of equal growth rates and costs of capital, investors prefer dividends in-hand to future capital gains due to uncertainty.
This document discusses methods for valuing different types of financial instruments including bonds, preference shares, and equity shares.
For bonds, it describes the different types including bonds with maturity, pure discount bonds, and perpetual bonds. It also defines relevant terms like coupon rate, maturity period, current yield, and yield to maturity. Formulas are provided for calculating yield to maturity and yield to call.
Preference shares are valued using the dividend discount model. Equity shares are more difficult to value since dividends may fluctuate or grow. Several dividend discount models are described for valuing equity including the no growth model, constant growth model, and multi-period models using dividends or earnings. The P/E ratio and its
The main types of dividends are cash dividends which are payments made to shareholders in cash, bonus shares which increase the number of shares held, and special dividends which are additional non-recurring payments over regular dividends usually due to abnormal profits. Dividends can also be interim dividends paid during the year or annual dividends paid once a year. Regular cash dividends refer to the expected annual dividend payments a company aims to maintain.
This document discusses the cost of capital and how it is calculated. It begins by defining cost of capital as the minimum rate of return a company must earn on an investment to maintain its value. It then discusses the different costs that make up the overall cost of capital, including:
- Cost of equity, which is the rate investors use to value the company's future dividend payments. It can be calculated using the dividend valuation model or capital asset pricing model.
- Cost of debt, which is the after-tax interest rate the company pays on its borrowed funds.
- Cost of preferred shares.
It explains that the weighted average cost of capital (WACC) weights each of these costs based on the
This document discusses dividend policy and several models for determining dividend policy, including the Walter model, Gordon model, and Modigliani-Miller model. The Walter model recommends that dividend policy influences share price and firm value. The Gordon model states that investors prefer constant dividend income. The Modigliani-Miller model suggests that dividend policy does not impact firm valuation if capital markets are perfect. Each model makes assumptions about financing, growth rates, and taxes. Formulas are provided for determining share price based on dividends, earnings, and cost of capital under each model.
The document discusses discounted cash flow (DCF) valuation, which values an asset based on the present value of its expected future cash flows, discounted at a rate reflecting the asset's risk. It provides two key propositions: 1) For an asset to have value, cash flows must be positive over its life. 2) Assets generating earlier cash flows are more valuable than those generating later cash flows. The document then discusses how DCF can be used for either equity valuation or firm valuation, and the differences in the discount rates and cash flows used for each. It provides steps for performing a DCF valuation, and defines economic value added (EVA) as net operating profits after tax minus a firm's weighted average cost of
1) Dividend policy involves determining the portion of earnings to distribute as dividends to shareholders versus retaining for reinvestment.
2) An optimal dividend policy balances maximizing shareholder wealth through current dividends and future growth funded by retained earnings.
3) Determining dividend policy considers factors like a company's growth opportunities, financial needs, and shareholders' preferences. Maintaining stability in dividend payouts is also important.
This document discusses various methods for valuing common stock, including:
1. The discounted cash flow model, which values a stock based on the present value of its expected future cash flows.
2. The dividend discount model (DDM), which values a stock based on the present value of its expected future dividends. Constant and variable growth DDM are discussed.
3. Other valuation methods like the free cash flow model, P/E ratio approach, and price-to-sales ratio are also presented. The document concludes that the best estimate of a stock's value is usually the present value of its estimated future dividends.
This document discusses dividend policy and the various theories around it. It defines dividends and discusses Walter's model and Gordon's model, which propose that dividend policy affects firm value. It also covers the irrelevance theories of Modigliani-Miller and the traditional approach, which argue that dividend policy does not impact value. The document provides formulas for the different models and discusses their assumptions and criticisms.
This document discusses dividend decision and theories. It defines dividends as the portion of profits distributed to shareholders. There are different types of dividends such as interim, final, stock, and scrip dividends. Dividend decision is influenced by legal provisions and is treated as a financing decision aimed at wealth maximization. The document discusses various dividend theories including the residual dividend policy, Modigliani-Miller's irrelevance theory, Walter's model, Gordon's model, and their underlying assumptions. It also covers factors influencing dividend policy and different approaches a company can take to its dividend policy.
This document provides an overview of the Advanced Corporate Finance course being taught by Dr. Santosh Kumar. The course will cover various topics related to valuation, risk analysis, and corporate restructuring decisions. It outlines the course objectives, topics, textbook, and assessment criteria. Students will be evaluated based on quizzes, assignments, projects, and an end-term exam. The goal is for students to learn techniques for valuing equity, debt, and firms, analyzing financial risk, and evaluating corporate decisions.
The document provides an overview of discounted cash flow (DCF) valuation. It discusses the history of DCF dating back to ancient times and its popularity after the 1929 stock market crash. It defines DCF valuation as estimating a company's value based on discounting its predicted future cash flows. The key steps in DCF valuation are estimating future cash flows, determining an appropriate discount rate, and calculating the present value of the future cash flows. DCF valuation requires numerous assumptions about cash flows, growth rates, and discount rates.
Long term financing involves raising funds for periods of 7 years or more, typically to finance fixed assets or permanent working capital needs. Common sources of long term financing include equity such as common stock or preferred stock, as well as debt instruments like bonds or bank loans. The costs of these various long term financing options must be calculated, taking into account factors like interest rates, dividend yields, maturity periods, tax rates, and flotation costs. The appropriate price or value is then determined for equity and debt instruments based on these cost of capital calculations and future cash flow expectations.
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Ähnlich wie chap 4 Stock and equity valuation revised .ppt
This document provides an overview of different valuation methods including discounted cash flow valuation using free cash flow to equity, free cash flow to the firm, and dividend discount models. It also covers residual income valuation and relative valuation. Details are given on the steps and considerations for each method, including projecting cash flows, estimating the terminal value, and determining appropriate discount rates. Guidelines are provided on when each valuation approach is most applicable.
This document discusses stock valuation using the Gordon Growth Model. It begins by introducing the Gordon Growth Model, which values a stock based on discounting the dividends that are distributed to shareholders. It then provides assumptions of the model, such as the business being stable and experiencing steady growth. The document also discusses estimating free cash flow to equity and financial leverage. It provides an example analysis of stock valuation for Consolidated Edison using the Gordon Growth Model.
Dividend Policy resolves two questions:
Question 1: Does dividend policy affect firm value?
Question 2: If so, What is the optimal level of distribution ratio i.e., % Net Income to be distributed as dividend (Payout ratio). These issues are discussed under Irrelevance Theories (Modigliani and Miller’s Model) and
Relevance Theories (Walter’s Model , Gordon’s Model)
The document discusses dividend decision and dividend policy. It defines dividends as profits distributed to shareholders. Dividend decision is made by company directors and impacts capital structure, stock price, and shareholder taxation. Determinants of dividend policy include payout ratio, stability, legal constraints, owners' needs, and capital market factors. Common dividend policies are regular, stable, and irregular. Dividends can be interim, proposed, final, unclaimed, etc. Various theories on the relationship between dividends and firm value are discussed, including whether dividends are relevant or irrelevant to value. Models by Walter, Gordon, and Miller-Modigliani are summarized.
The document outlines topics related to stock valuation including: differentiating between debt and equity; features of common and preferred stock; the process of issuing common stock; market efficiency and basic stock valuation models; free cash flow valuation and other approaches like book value and P/E multiples; and the relationships between financial decisions, risk, return, and firm value. The document contains sections on these topics and will provide information to understand concepts of stock valuation.
This document discusses various methods for valuing stocks, including discounted cash flow models like the dividend discount model and free cash flow models. It compares the cash flows to bond investors versus equity investors. Key valuation methods covered include relative valuation using price-earnings ratios and multiples of book value per share. The document also provides examples of calculating stock values using these various approaches.
The document discusses various methods for valuing common stock, including calculating the present value of future dividends using the dividend discount model. It outlines three cases for the pattern of future dividends: zero growth, constant growth, and non-constant growth. Key valuation formulas and an example are provided. Additional stock features and components of the required return such as the dividend yield and capital gains yield are also examined.
The document discusses several theories on corporate dividend policies:
1. Dividend relevance theories argue that a firm's dividend policy impacts its value. Walter's and Gordon's models show how value is determined based on factors like earnings, dividends, growth rates, and costs of capital.
2. Dividend irrelevance theories, proposed by Modigliani and Miller, state that a firm's value depends only on its investment policy, not its dividend policy.
3. The bird-in-hand theory suggests that even in situations of equal growth rates and costs of capital, investors prefer dividends in-hand to future capital gains due to uncertainty.
This document discusses methods for valuing different types of financial instruments including bonds, preference shares, and equity shares.
For bonds, it describes the different types including bonds with maturity, pure discount bonds, and perpetual bonds. It also defines relevant terms like coupon rate, maturity period, current yield, and yield to maturity. Formulas are provided for calculating yield to maturity and yield to call.
Preference shares are valued using the dividend discount model. Equity shares are more difficult to value since dividends may fluctuate or grow. Several dividend discount models are described for valuing equity including the no growth model, constant growth model, and multi-period models using dividends or earnings. The P/E ratio and its
The main types of dividends are cash dividends which are payments made to shareholders in cash, bonus shares which increase the number of shares held, and special dividends which are additional non-recurring payments over regular dividends usually due to abnormal profits. Dividends can also be interim dividends paid during the year or annual dividends paid once a year. Regular cash dividends refer to the expected annual dividend payments a company aims to maintain.
This document discusses the cost of capital and how it is calculated. It begins by defining cost of capital as the minimum rate of return a company must earn on an investment to maintain its value. It then discusses the different costs that make up the overall cost of capital, including:
- Cost of equity, which is the rate investors use to value the company's future dividend payments. It can be calculated using the dividend valuation model or capital asset pricing model.
- Cost of debt, which is the after-tax interest rate the company pays on its borrowed funds.
- Cost of preferred shares.
It explains that the weighted average cost of capital (WACC) weights each of these costs based on the
This document discusses dividend policy and several models for determining dividend policy, including the Walter model, Gordon model, and Modigliani-Miller model. The Walter model recommends that dividend policy influences share price and firm value. The Gordon model states that investors prefer constant dividend income. The Modigliani-Miller model suggests that dividend policy does not impact firm valuation if capital markets are perfect. Each model makes assumptions about financing, growth rates, and taxes. Formulas are provided for determining share price based on dividends, earnings, and cost of capital under each model.
The document discusses discounted cash flow (DCF) valuation, which values an asset based on the present value of its expected future cash flows, discounted at a rate reflecting the asset's risk. It provides two key propositions: 1) For an asset to have value, cash flows must be positive over its life. 2) Assets generating earlier cash flows are more valuable than those generating later cash flows. The document then discusses how DCF can be used for either equity valuation or firm valuation, and the differences in the discount rates and cash flows used for each. It provides steps for performing a DCF valuation, and defines economic value added (EVA) as net operating profits after tax minus a firm's weighted average cost of
1) Dividend policy involves determining the portion of earnings to distribute as dividends to shareholders versus retaining for reinvestment.
2) An optimal dividend policy balances maximizing shareholder wealth through current dividends and future growth funded by retained earnings.
3) Determining dividend policy considers factors like a company's growth opportunities, financial needs, and shareholders' preferences. Maintaining stability in dividend payouts is also important.
This document discusses various methods for valuing common stock, including:
1. The discounted cash flow model, which values a stock based on the present value of its expected future cash flows.
2. The dividend discount model (DDM), which values a stock based on the present value of its expected future dividends. Constant and variable growth DDM are discussed.
3. Other valuation methods like the free cash flow model, P/E ratio approach, and price-to-sales ratio are also presented. The document concludes that the best estimate of a stock's value is usually the present value of its estimated future dividends.
This document discusses dividend policy and the various theories around it. It defines dividends and discusses Walter's model and Gordon's model, which propose that dividend policy affects firm value. It also covers the irrelevance theories of Modigliani-Miller and the traditional approach, which argue that dividend policy does not impact value. The document provides formulas for the different models and discusses their assumptions and criticisms.
This document discusses dividend decision and theories. It defines dividends as the portion of profits distributed to shareholders. There are different types of dividends such as interim, final, stock, and scrip dividends. Dividend decision is influenced by legal provisions and is treated as a financing decision aimed at wealth maximization. The document discusses various dividend theories including the residual dividend policy, Modigliani-Miller's irrelevance theory, Walter's model, Gordon's model, and their underlying assumptions. It also covers factors influencing dividend policy and different approaches a company can take to its dividend policy.
This document provides an overview of the Advanced Corporate Finance course being taught by Dr. Santosh Kumar. The course will cover various topics related to valuation, risk analysis, and corporate restructuring decisions. It outlines the course objectives, topics, textbook, and assessment criteria. Students will be evaluated based on quizzes, assignments, projects, and an end-term exam. The goal is for students to learn techniques for valuing equity, debt, and firms, analyzing financial risk, and evaluating corporate decisions.
The document provides an overview of discounted cash flow (DCF) valuation. It discusses the history of DCF dating back to ancient times and its popularity after the 1929 stock market crash. It defines DCF valuation as estimating a company's value based on discounting its predicted future cash flows. The key steps in DCF valuation are estimating future cash flows, determining an appropriate discount rate, and calculating the present value of the future cash flows. DCF valuation requires numerous assumptions about cash flows, growth rates, and discount rates.
Long term financing involves raising funds for periods of 7 years or more, typically to finance fixed assets or permanent working capital needs. Common sources of long term financing include equity such as common stock or preferred stock, as well as debt instruments like bonds or bank loans. The costs of these various long term financing options must be calculated, taking into account factors like interest rates, dividend yields, maturity periods, tax rates, and flotation costs. The appropriate price or value is then determined for equity and debt instruments based on these cost of capital calculations and future cash flow expectations.
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2. • Equity market is one of the key sectors of financial markets
where long -term financial instruments are traded.
• The purpose of equity instruments issued by corporations is to raise
funds for the firms. The provider of the funds is granted a residual
claim on the company’s income, and becomes one of the owners of
the firm.
• For market participants equity securities mean holding wealth as well
as a source of new finance, and are of great significance for
savings and investment process in a market economy.
• Within the savings-investment process magnitude of retained
earnings exceeds that of the news stock issues and constitutes the
main source of funds for the firms.
• Equity instruments can be traded publicly and privately.
• Internal equity financing of companies is provided through
retained earnings; whereas the external source of equity is provided
through stock issuance.
3. Fundamental Stock Analysis:
Models of Equity Valuation
Basic Types of Models
Balance Sheet Models
Dividend Discount Models
Price/Earning Ratios
Estimating Growth Rates and
Opportunities
4. Intrinsic Value and Market Price
Intrinsic Value
Self assigned Value
Variety of models are used for estimation
Market Price
Consensus value of all potential traders
Trading Signal
IV > MP Buy
IV < MP Sell or Short Sell
IV = MP Hold or Fairly Priced
5. Common Stock as Residual Ownership
Common stock is quite different than
bonds and preferred stock:
Return is dependent upon success of firm
Provides a residual claim on firm’s assets
Ownership rights to cash flows remaining
after all other claims are paid
Not a contractual obligation and no stated
maturity
6. Difficulty of Estimating
Common Stock Value
The value of a security is the sum of the
present values of its future expected cash
flows. Common stock is difficult to value
because future cash flows are uncertain.
Future common stock dividends are difficult to
forecast accurately.
The future common stock selling price is
difficult to forecast.
7. Valuation of common Stocks
Process of determining the fair market value
of a financial asset on the basis of present
value of the expected cash flows
Three step process:
Estimate the expected cash flows
Determine the appropriate discount rate or
required rates of return to discount the cash flows
Compute the present value of the expected cash
flows in step 1 by discounted them with discunt
rate(s) in step 2
8. Value of Common-Stock
Two forms of expected cash flows from
common stocks:
1. Dividends received over investor’s
stock holding period
2. Price expected to be received when
stock is sold
9. Value of a Common Stock
The intrinsic Value of a common stock
equals PV of cash flows from a stock
which is:
1. PV of an infinite dividend stream OR
2. PV of a finite dividend stream plus PV
of the sale price of the stock
10. Common stock valuation
Common stocks can be valued using:
1. Dividend Discounted model
(DDM)
2. Free cash Flow to Equity
(FCFE) model
11. Dividend Discount Model
If the stock is held for finite period, Value of a
share of common stock is the present value of
all future dividends
If finite holding period there are two types of
expected cash flows
Dividends during the holding period
Expected price at the end of holding period—this
itself is dependent on future dividends
12. Specified/finite Holding Period Model
0
1
1
2
2
1 1 1
V
D
k
D
k
D P
k
N N
N
( ) ( ) ( )
...
PN = the expected sales price for the stock at
time N
N = the specified number of years the stock is
expected to be held
Vo – is value of stock
K- is RRR
13. Infinite Holding Period
What will be the value of a share of common
stock?
Present value of an infinite stream of anticipated
dividends
Simplified assumptions to simply valuation
model
Zero Growth Model
Constant Growth Model
Two-stage growth model
14. Zero Growth Model
Dividend every year will be the same
Investor anticipates to receive the same
amount dividend per year forever
DPS
Vs = -------------
rcs
15. No Growth Model
V
D
k
o
Stocks that have earnings and dividends that
are expected to remain constant
Preferred Stock
16. No Growth Model: Example
E1 = D1 = $5.00
k = .15
V0 = $5.00 / .15 = $33.33
V
D
k
o
17. Constant Growth Model
Assume that firm grows at a stable
growth rate of g per year forever
DPS1
Vs = ---------, where r>g
r - g
19. Constant Growth Model: Example
Vo
D g
k g
o
( )
1
E1 = $5.00 b = 40% k = 15%
(1-b) = 60% D1 = $3.00 g = 8%
V0 = 3.00 / (.15 - .08) = $42.86
20. Two-Stage DDM
In general version of the model, two stages
of growth
An initial period of extraordinary growth
After initial period, a period of stable growth
n DPSt Pn
P0 = ---------- + ---------
t=1 (1+r)t (1 + r)n
DPSn+1
Where Pn = -----------------
(r – gn)
21. Shifting Growth Rate Model
V D
g
k
D g
k g k
o o
t
t
t
T
T
T
( )
( )
( )
( )( )
1
1
1
1
1
1
2
2
g1 = first growth rate
g2 = second growth rate
T = number of periods of growth at g1
24. Four Basic Inputs
Length of high growth period
Dividends per share each period
Required rate of return by stockholders
each period
Terminal price at the end of high
growth period
25. How do we Estimate Growth
Rate?
If the firm’s dividend growth rate is not
known, it can be estimated using two
ways:
1. geometric mean of past dividend
growth.
2. Retention model
26. How do we Estimate Growth Rate?
1. geometric mean of past dividend.
g = -1
Where
rn …dividend growth rate in nth year
G … dividend growth rate
2. Retention growth model
Most firms pay out some of their net
income as dividends and reinvest, or
retain, the rest.
g = (retention rate) (ROE)
n rn
r
r
r )
1
)...(
3
1
)(
2
1
)(
1
1
(
27. Estimating Dividend Growth Rates
g ROE b
g = growth rate in dividends
ROE = Return on Equity for the firm
b = plowback or retention percentage
rate
(1- dividend payout percentage rate)
28. Example
Ameritech Corporation just paid dividends per share
of $7.04 and dividends are expected to grow 5% a
year forever. The stock has a beta of 0.90 the
market risk premium is 7.5 % and the treasury
bond rate is 6.25%.
a)What is the current value per share, using the
DDM?
b)The stock was trading for $80 per share. What
would the growth rate in dividends have to be to
justify this price?
29. Example: multiple growth rate
Chain Reaction, Inc., has been growing at a
phenomenal rate of 30 percent per year
because of its rapid expansion and explosive
sales. You believe that this growth rate will
last for three more years and that the rate
will then drop to 10 percent per year. The
growth rate then remains at 10 percent
indefinitely. Total dividends just paid were $5
million, and the required return is 20 percent.
Require: what is the total value of the stock?
30. Exercise
The next dividend for the Gordon Growth
Company will be $4 per share. Investors require a
16 percent return on companies such as Gordon.
Gordon’s dividend increases by 6 percent every
year. Based on the dividend growth model, what is
the value of Gordon’s stock today?
Required: What is the value in four years?
31. Price Earnings Ratios
P/E Ratios are a function of two factors
Required Rates of Return (k)
Expected growth in Dividends
Uses
Relative valuation
Extensive Use in industry
32. P/E Ratio: No expected growth
P
E
k
P
E k
0
1
0
1
1
E1 - expected earnings for next year
E1 is equal to D1 under no growth
k - required rate of return
33. P/E Ratio with Constant Growth
P
D
k g
E b
k b ROE
P
E
b
k b ROE
0
1 1
0
1
1
1
( )
( )
( )
b = retention ration
ROE = Return on Equity
34. Numerical Example: No Growth
E0 = $2.50 g = 0 k = 12.5%
P0 = D/k = $2.50/.125 = $20.00
PE = 1/k = 1/.125 = 8
35. Numerical Example with Growth
b = 60% ROE = 15% (1-b) = 40%
E1 = $2.50 (1 + (.6)(.15)) = $2.73
D1 = $2.73 (1-.6) = $1.09
k = 12.5% g = 9%
P0 = 1.09/(.125-.09) = $31.14
PE = 31.14/2.73 = 11.4
PE = (1 - .60) / (.125 - .09) = 11.4
36. Free Cash Flow to Equity
(FCFE) Valuation Model
The cash flow that the firm can afford
as dividends and contrasted with actual
dividends—may not payout as dividends
The residual cash flow left over after
meeting interest and principal payments
and providing for capital expenditures is
the FCFE
37. FCFE…
FCFE model is suitable under the following
conditions :
the firm is not dividend paying, or
the firm is dividend paying but dividends differ
significantly from the firm’s capacity to pay
dividends,
FCFE =FCFF-Interest exp (1- tax rate) + net
borrowing
Where FCFF … is free cash flow to the firm
38. FCFE ….
FCFE is the cash flow from operations minus
capital expenditures minus payments to (and
plus receipts from) debt-holders.
Computed as:
FCFE = Net Income
+ non cash charges (Income)
- Capital Spending
+ net borrowing
39. Valuing FCFE
The value of equity can be found by discounting
FCFE at the required rate of return on equity (r):
Since FCFE is the cash flow remaining for equity
holders after all other claims have been satisfied,
discounting FCFE by r (the required rate of return
on equity) gives the value of the firm’s equity.
Dividing the total value of equity by the number of
outstanding shares gives the value per share.
1
FCFE
Equity Value
(1 )
t
t
t r
40. Constant-growth FCFE valuation
model
FCFE in any period will be equal to FCFE in the
preceding period times (1 + g):
FCFEt = FCFEt–1 (1 + g).
The value of equity if FCFE is growing at a
constant rate is
The discount rate is r, the required return on
equity. The growth rate (g) is the growth rate
of FCFE.
0
1 FCFE (1 )
FCFE
Equity Value
g
r g r g
41. Example
Gray Furniture Company earned net income of $350,000
last year. Investment in fixed capital was $200,000,
depreciation was $160,000, and the investment in working
capital was $50,000. Gray is currently operating at its
target debt-to-asset ratio of 40%. Thus, 40% of annual
investments in working capital and fixed capital will be
financed with new borrowings. Shareholders require a
return of 14% on their investment, and the expected
growth rate of the FCFE is 4%. The company has 100,000
outstanding shares.
Required: what is the value of Gray company’s stock?
42. Example 2
Ridgeway Construction has FCFE of $ 2,500,000 and
1 million shares. The firm is currently operating at a
target debt-to-equity ratio of 0.4. The expected
return on the market is 9%, the risk free rate is 4%,
and Ridgeway stock has a beta of 1.5. The expected
growth rate of FCFE is 4.5%.
Required:
A) Calculate the value of Ridgeway stock
B) What is the total value of Ridgeway company
43. Types of Stock Analysis
Technical Analysis - using prices and
volume information to predict
future prices
Weak form efficiency & technical analysis
Fundamental Analysis - using
economic and accounting
information to predict stock prices
Semi strong form efficiency & fundamental analysis
44. • Fundamental analysis is one of the methods of
valuing stocks, which involves the analysis of a
company’s operations to assess its economic prospects.
• It is based on fundamental financial characteristics
(e.g. earnings) about the company and its
corresponding industry that are expected to influence
stock values.
• The analysis is based on financial statements of the
company in order to investigate the earnings, cash
flow, profitability, and financial leverage.
• The fundamental analysis includes analysis of the
major product lines, the economic outlook for the
products (including existing and potential competitors),
and the industries in which the company operates.
45. • This analysis results in projections of earnings growth.
Based on the growth prospects of earnings, the fair value
of the stock using one or more of the equity valuation
models is determined.
• The fair value is based on present value calculations.
• Present value –the current value of a future cash flow.
• It is obtained by discounting future cash flow by
the market –required rate of return.
• There are various models to estimate the fundamental
value of company shares.
• One approach is to estimate expected earnings and then
multiply by expected price/ earnings ratio.
• Another approach is to estimate the value of the assets of
the company.
46. • The estimated fair value is compared to the market price to
determine if the stock is fairly priced in the market, cheap
(a market price below the estimated fair value), or rich
(a market price above the estimated fair value).
• In a perfectly efficient market all securities are always
correctly priced.
• The market price equals to the fundamental value of the
security.
• In a market that is partially inefficient, the market prices
deviate from fundamental value.
• Financial analysts aim to discover the fundamental value
ahead of the rest of the market participants before the
market prices approach the fundamental value in order
to make profits.
• The actions of such profit seeking investors push the
47. Technical Analysis
• The aim of the technical analysis is to identify stocks
that are candidates for purchase or sale, and the
investor can employ technical analysis to define the
time of the purchase or sale.
• Such analysis is used not only for investigation of
common shares, but also in the trading of
commodities, bonds, and futures contracts.
• This analysis can be traced back to the seventeenth
century, where it was applied in Japan to analyze the
trend in the price of rice.
• The father of modern technical analysis is Charles
Dow, a founder of the Wall Street Journal and its first
editor in the period of 1889 -December 1902.
48. • Technical analysis ignores company
fundamental information, focusing instead on
the study of internal stock market
information on price and trading volume of
individual stocks, groups of stocks, and the
overall market, resulting from shifting supply
and demand.
• Technical analysts believe that stock markets
have a dynamic of their own, independent of
outside economic forces.
• Technical analysis – a forecasting method for
asset prices based solely on information about
the past prices.
49. • Technical analysis is aimed to determine past
market trends and patterns from which
predictions of future market behavior are derived.
• It attempts to forecast short-term price
movements.
• The methodology of analysis is based on the belief
that stock market history tends to repeat itself.
• If a certain pattern of prices and volumes has
previously been followed by particular price
movements, it is suggested that a repetition of that
pattern will be followed by similar price
movements.