Stock valuation Types of stock How shares are

Stock valuation • Types of stock • How shares are sold • Stock Valuation Techniques www. Assignment. Point. com

Types of stock • Common stock – provides the permanent long-term financing of a firm – represents the true residual ownership of a firm – carries the right to vote on corporate policy and the composition of the board of directors • Preferred stock – carries no voting rights – has preference over common stock in the payment of dividends and claims on assets – usually has a fixed dividend. www. Assignment. Point. com

How shares of stock are sold • Public cash offering – Selling securities through investment banks to the public • Private or direct placement – Placing a security issue with one or more large investors • Rights offering – Selling common stock to existing shareholders • Standby underwriting – Investment bankers purchase shares not sold to the rights holder. www. Assignment. Point. com

Cash flows to stockholders • If you buy a share of stock, you can receive cash in two ways – The company pays dividends – You sell your shares either to another investor in the market or back to the company • The price of the stock is the present value of these expected cash flows. www. Assignment. Point. com

One period example • Suppose you are thinking of purchasing the stock of Union Capital Limited. You expect it to pay a 20 Taka dividend in one year, and you believe that you can sell the stock for 140 Taka 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? • Compute the PV of the expected cash flows • Price = (140 + 20) / (1. 2) = Taka 133. 33 www. Assignment. Point. com

Two period example • Now, what if you decide to hold the stock for two years? In addition to the 20 Taka dividend in one year, you expect a dividend of 21 Taka and a stock price of 147 Taka both at the end of year 2. Now how much would you be willing to pay? • Compute the PV of the expected cash flows • Price = 20 / (1. 2) + (21 + 147) / (1. 2)2 = Taka 133. 33 www. Assignment. Point. com

Three period example • Finally, what if you 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 Taka 22. 05 and a stock price of Taka 154. 35 both at the end of year 3. Now how much would you be willing to pay? • Compute the PV of the expected cash flows • Price = 20/ 1. 2 + 21 / (1. 2)2 + (22. 05 + 154. 35) / (1. 2)3 = Taka 133. 33 www. Assignment. Point. com

Developing the model • You could continue to push back when you would sell the stock • You would find that the price of the stock is really just the present value of all expected future dividend payments • So, how can we estimate all future dividend payments? www. Assignment. Point. com

Constant dividend/zero growth • If dividends are expected at regular intervals forever, then this is valued as a perpetuity. P 0 = D / R • A stock pays 50 Taka dividend every quarter. The required rate of return is 10% with quarterly compounding. What is the price? P 0 = 50 / (0. 10/4) = 50 / 0. 025 = 2000 Taka www. Assignment. Point. com

Dividend growth model • If dividends are expected to grow at a constant percent period, then this is valued as follows. P 0 = D 0 (1+g) / (R-g) • Suppose CS Capital just paid a dividend of 50 Taka. It is expected to increase its dividend by 2% per year. If the market requires a return of 15% on assets of this risk, how much should the stock be selling for? P 0 = 50 (1+0. 02) / (0. 15 – 0. 02) = 392 Taka www. Assignment. Point. com

Dividend growth model • If dividends are expected to grow at a constant percent period, then this is valued as follows. P 0 = D 1 / (R-g) • Suppose CS Capital is expected to pay a 20 Taka dividend in one year. If the dividend is expected to grow at 5% per year and the required return is 20%, what is the price? P 0 = 20 / (0. 20 – 0. 05) = 133 Taka www. Assignment. Point. com

Finding the required return • You can use the DGM to find the value of R. R = (D 1 / P 0) + g • Suppose a firm’s stock is selling for 105 Taka. It just paid a 10 Taka dividend and dividends are expected to grow at 5% per year. What is the required return? R = [10*(1. 05) / 105] + 0. 05 = 15% www. Assignment. Point. com

Dividend yield, cap gains yield • You can use the DGM to find the value of R. R = (D 1 / P 0) + g • (D 1 / P 0) is known as the dividend yield. • g is the capital gains yield. • In the last example: R = [10*(1. 05) / 105] + 0. 05 = 15% Dividend yield = 10 *1. 05 / 105 = 10% Capital gains yield = 0. 05 = 5% www. Assignment. Point. com

Self-assessment problems • A stock currently sells for 500 Taka per share. The next expected annual dividend is 20 Taka, and the growth rate is 6%. What is the expected rate of return on this stock? • If the required rate of return on this stock were 12%, what would the stock price be, and what would the dividend yield be? www. Assignment. Point. com

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