1、McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/IrwinEquity Markets and Stock ValuationChapter 7McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.1Key Concepts and SkillsnUnderstand how stock prices depend on future dividends and div
2、idend growthnBe able to compute stock prices using the dividend growth modelnUnderstand how corporate directors are electednUnderstand how stock markets worknUnderstand how stock prices are quotedMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.2Chapter OutlinenC
3、ommon Stock ValuationnSome Features of Common and Preferred StocksnThe Stock MarketsMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.3Cash Flows to StockholdersnIf you buy a share of stock,you can receive cash in two waysnThe company pays dividendsnYou sell your
4、shares,either to another investor in the market or back to the companynAs with bonds,the price of the stock is the present value of these expected cash flows McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.4One Period ExamplenSuppose you are thinking of purchasi
5、ng the stock of Moore Oil,Inc.and 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?nCompute the PV of the expected cash flowsnPrice=(
6、14+2)/(1.2)=$13.33nOr FV=16;I/Y=20;N=1;CPT PV=-13.33McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.5Two Period ExamplenNow 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 and a stock pr
7、ice of$14.70 at the end of year 2.Now how much would you be willing to pay?nPV=2/(1.2)+(2.10+14.70)/(1.2)2=13.33nOr CF0=0;C01=2;F01=1;C02=16.80;F02=1;NPV;I=20;CPT NPV=13.33McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.6Three Period ExamplenFinally,what if you
8、decide to hold the stock for three periods?In addition to the dividends at the end of years 1 and 2,you expect to receive a dividend of$2.205 at the end of year 3 and a stock price of$15.435.Now how much would you be willing to pay?nPV=2/1.2+2.10/(1.2)2+(2.205+15.435)/(1.2)3=13.33nOr CF0=0;C01=2;F01
9、=1;C02=2.10;F02=1;C03=17.64;F03=1;NPV;I=20;CPT NPV=13.33McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.7Developing The ModelnYou could continue to push back when you would sell the stocknYou would find that the price of the stock is really just the present valu
10、e of all expected future dividendsnSo,how can we estimate all future dividend payments?McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.8Estimating Dividends:Special CasesnConstant dividendnThe firm will pay a constant dividend forevernThis is like preferred stoc
11、knThe price is computed using the perpetuity formulanConstant dividend growthnThe firm will increase the dividend by a constant percent every periodnSupernormal growthnDividend growth is not consistent initially,but settles down to constant growth eventuallyMcGraw-Hill 2004 The McGraw-Hill Companies
12、,Inc.All rights reserved.McGraw-Hill/Irwin7.9Zero GrowthnIf dividends are expected at regular intervals forever,then this is like preferred stock and is valued as a perpetuitynP0=D/RnSuppose stock is expected to pay a$0.50 dividend every quarter and the required return is 10%with quarterly compoundi
13、ng.What is the price?nP0=.50/(.1/4)=$20McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.10Dividend Growth ModelnDividends are expected to grow at a constant percent per period.nP0=D1/(1+R)+D2/(1+R)2+D3/(1+R)3+nP0=D0(1+g)/(1+R)+D0(1+g)2/(1+R)2+D0(1+g)3/(1+R)3+nWit
14、h a little algebra,this reduces to:g-RDg-Rg)1(DP100McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.11DGM Example 1nSuppose Big D,Inc.just paid a dividend of$.50.It is expected to increase its dividend by 2%per year.If the market requires a return of 15%on assets
15、 of this risk,how much should the stock be selling for?nP0=.50(1+.02)/(.15-.02)=$3.92McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.12DGM Example 2nSuppose TB Pirates,Inc.is expected to pay a$2 dividend in one year.If the dividend is expected to grow at 5%per y
16、ear and the required return is 20%,what is the price?nP0=2/(.2-.05)=$13.33nWhy isnt the$2 in the numerator multiplied by(1.05)in this example?McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.13Stock Price Sensitivity to Dividend Growth,gD1=$2;R=20%McGraw-Hill 200
17、4 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.14Stock Price Sensitivity to Required Return,RD1=$2;g=5%McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.15Example 7.3 Gordon Growth Company-InGordon Growth Company is expected to pay a divide
18、nd of$4 next period and dividends are expected to grow at 6%per year.The required return is 16%.nWhat is the current price?nP0=4/(.16-.06)=$40nRemember that we already have the dividend expected next year,so we dont multiply the dividend by 1+gMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All right
19、s reserved.McGraw-Hill/Irwin7.16Example 7.3 Gordon Growth Company IInWhat is the price expected to be in year 4?nP4=D4(1+g)/(R g)=D5/(R g)nP4=4(1+.06)4/(.16-.06)=50.50nWhat is the implied return given the change in price during the four year period?n50.50=40(1+return)4;return=6%nPV=-40;FV=50.50;N=4;
20、CPT I/Y=6%nThe price grows at the same rate as the dividendsMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.17Nonconstant Growth Problem StatementnSuppose a firm is expected to increase dividends by 20%in one year and by 15%in two years.After that dividends will
21、 increase at a rate of 5%per year indefinitely.If the last dividend was$1 and the required return is 20%,what is the price of the stock?nRemember that we have to find the PV of all expected future dividends.McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.18Nonco
22、nstant Growth Example SolutionnCompute the dividends until growth levels offnD1=1(1.2)=$1.20nD2=1.20(1.15)=$1.38nD3=1.38(1.05)=$1.449nFind the expected future pricenP2=D3/(R g)=1.449/(.2-.05)=9.66nFind the present value of the expected future cash flowsnP0=1.20/(1.2)+(1.38+9.66)/(1.2)2=8.67McGraw-Hi
23、ll 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.19Quick Quiz:Part 1nWhat is the value of a stock that is expected to pay a constant dividend of$2 per year if the required return is 15%?nWhat if the company starts increasing dividends by 3%per year,beginning with the next
24、 dividend?The required return stays at 15%.McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.20Using the DGM to Find RnStart with the DGM:gPD gPg)1(D RRfor solve and rearrangeg-RDg -Rg)1(DP0100100McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.M
25、cGraw-Hill/Irwin7.21Finding the Required Return-ExamplenSuppose a firms stock is selling for$10.50.They just paid a$1 dividend and dividends are expected to grow at 5%per year.What is the required return?nR=1(1.05)/10.50+.05=15%nWhat is the dividend yield?n1(1.05)/10.50=10%nWhat is the capital gains
26、 yield?ng=5%McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.22Table 7.1McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.23Features of Common StocknVoting RightsnProxy votingnClasses of stocknOther RightsnShare proportionally
27、in declared dividendsnShare proportionally in remaining assets during liquidationnPreemptive right first shot at new stock issue to maintain proportional ownership if desiredMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.24Dividend CharacteristicsnDividends are
28、 not a liability of the firm until a dividend has been declared by the BoardnConsequently,a firm cannot go bankrupt for not declaring dividendsnDividends and TaxesnDividend payments are not considered a business expense,therefore,they are not tax deductiblenDividends received by individuals are taxe
29、d as ordinary incomenDividends received by corporations have a minimum 70%exclusion from taxable incomeMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.25Features of Preferred StocknDividendsnStated dividend that must be paid before dividends can be paid to commo
30、n stockholdersnDividends are not a liability of the firm and preferred dividends can be deferred indefinitelynMost preferred dividends are cumulative any missed preferred dividends have to be paid before common dividends can be paidnPreferred stock generally does not carry voting rightsMcGraw-Hill 2
31、004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.26Stock MarketnDealers vs.BrokersnNew York Stock Exchange(NYSE)nMembersnOperationsnFloor activitynNASDAQnNot a physical exchange computer based quotation systemnLarge portion of technology stocksMcGraw-Hill 2004 The McGraw-Hill
32、 Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.27Work the Web ExamplenElectronic Communications Networks provide trading in NASDAQ securitiesnThe Island allows the public to view the“order book”in real timenClick on the web surfer and visit The Island!McGraw-Hill 2004 The McGraw-Hill Companie
33、s,Inc.All rights reserved.McGraw-Hill/Irwin7.28Reading Stock QuotesnSample Quote19.2 57.91 42.59 Coca-Cola KO .80 1.4 36 26927 56.20 +0.74nWhat information is provided in the stock quote?McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin7.29Quick Quiz:Part 2nYou observe a stock price of$18.75.You expect a dividend growth rate of 5%and the most recent dividend was$1.50.What is the required return?nWhat are some of the major characteristics of common stock?nWhat are some of the major characteristics of preferred stock?
