Fundamentals of corporate finance 10e ROSS JORDAN chap008

Chapter 8

Stock Valuation

8-1

McGraw-Hill/Irwin

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.


Chapter Outline

•
•
•
•
•

8-2

Bond and Stock Differences
Common Stock Valuation
Features of Common Stock
Features of Preferred Stock
The Stock Markets


Chapter Outline

•

•
•
•
•

8-3

Bond and Stock Differences
Common Stock Valuation
Features of Common Stock
Features of Preferred Stock
The Stock Markets


Bonds and Stocks: Similarities

•

Both provide long-term funding for the organization

•

Both are future funds that an investor must
consider

•

Both have future periodic payments

•

Both can be purchased in a marketplace at a price
“today”

8-4


Bonds and Stocks: Differences

•

From the firm’s perspective: a bond is a long-term debt
and stock is equity

•

From the firm’s perspective: a bond gets paid off at the
maturity date; stock continues indefinitely.

•

We will discuss the mix of bonds (debt) and stock
(equity) in a future chapter entitled capital structure

8-5


Bonds and Stocks: Differences

•

A bond has coupon payments and a lump-sum
payment; stock has dividend payments forever

•

Coupon payments are fixed; stock dividends
change or “grow” over time

8-6


A visual representation of a bond with a
coupon payment (C) and a maturity value
(M)

1

$C 1

2

$C 2

3

$C 3

4

5

$C 4

$C 5
$M

8-7


A visual representation of a share of
common stock with dividends (D)
forever
1

$D 1

8-8

2

$D 2

3

$D 3

4

5

$D 4

$D 5

∞

$D

∞


Comparison Valuations
Bond

0

1

2

P0

C

C

3

C

M

Common Stock
0

P0

8-9

1

2

3

D1

D2

D3

D

∞


Notice these differences:

•
•

•

The “C’s” are constant and equal
The bond ends (year 5 here)
There is a lump sum at the end

1

$C 1

2

$C 2

3

$C 3

4

5

$C 4

$C 5
$M

8-10

Notice these differences:

•
•
•

The dividends are different
The stock never ends
There is no lump sum

1

$D 1

8-11

2

$D 2

3

$D 3

4

5

$D 4

$D 5

∞

∞

$D


Chapter Outline

•
•
•
•
•

8-12

Bond and Stock Differences
Common Stock Valuation
Features of Common Stock
Features of Preferred Stock
The Stock Markets


Our Task:
To value a share of
Common Stock

8-13


And how will we
accomplish our task?

8-14


8-15

B

Bring

A

All

E

Expected

F

Future

E

Earnings

I

Into

P

Present

V

Value

T

Terms


Just remember:

BAEFEIPVT

8-16


Cash Flows for Stockholders
If you buy a share of stock, you can
receive cash in two ways:

1. The company pays dividends

2. You sell your shares, either to
another investor in the
market or back to the
company

8-17


One-Period Example
Receiving one future dividend and one
future selling price of a share of
common stock

8-18


One-Period Example
Suppose you are thinking of purchasing the stock
of Moore Oil, Inc. You expect it to pay a $2
dividend in one year, and you believe that you can
sell the stock for $14 at that time.
If you require a return of 20% on investments of
this risk, what is the maximum you would be
willing to pay?

8-19


Visually this would look like:
1

R = 20%

D1 = $2
P1 = $14

8-20


Compute the Present Value
1
R = 20%

$1.67
$11.67
PV =$13.34

8-21

D1 = $2
P1 = $14


TI BA II Plus

1 year = N

-13.34
20% = Discount rate

$2 = Payment (PMT)

$14 = FV

1st
2nd

8-22

PV = ?


1 year = N

HP 12-C

20% = Discount rate
$2 = Payment (PMT)
PV = ?

$14 = FV

-13.34

8-23


Two Period Example
Now, what if you decide to hold the stock for two
years? In addition to the dividend in one year,
you expect a dividend of $2.10 in two years and

a stock price of $14.70 at the end of year. Now
how much would you be willing to pay?

8-24


Visually this would look like:
R = 20%

1

D1 = $2

2

D2 = $ 2.10
P2 = $14.70

8-25