CF

473.32

8

Winter 2014

Stock Valuation

ch 8

Stocks Similar to Bonds

real world imaginary world

Real World First

dividends regular payments not a liability of the firm

• until a dividend declared by Board

can’t go bankrupt for not declaring dividends

Real World

dividend taxation• not considered a business expense

• not tax deductible

however• corporations

don’t pay taxes on dividends

• individuals partially sheltered by dividend tax credit

Real World

shareholders common preferred

Real World

common stockholders usual rights

• voting

• preemptive right

• share proportionally in declared dividends remaining assets during liquidation

Real World

preferred stockholders usually don’t vote

preferred stock stated dividend

• must be paid before common dividends

can be deferred indefinitely most are cumulative

• any missed must be paid before common

Real World

a shareholder receives cash in 2 ways company pays dividends sell shares

Imaginary World

In “theory”

dividends future expected allpricestock PV

dividends future expected all PVPVs

price sale expectedexpected dividends PV PVPVS

Moore Oil 1

suppose 1 year from now, you think

• will receive $2 dividend

• can sell stock for $14

if you want a 20% return to make something this risky

worth investing in

What’s the most you would pay?

Moore Oil 1

price sale expectedexpected dividends PV PVPVs

price saledividend PV PVPVs

sd ts

td

sr)(

FV

r)(

FV PV

11

?sPV

.200 r

1st

1 dt

0014$ .FVs

002$ . FVd

11

2001

0014$

2001

002$

).(

.

).(

. PVs 3313$ .PVs

Moore Oil 2

suppose you think• $2.00 dividend in 1 year

• $2.10 dividend in 2 years

• can sell the stock in 2 years for $14.70

still want• 20% return

What’s the most you would pay?

Moore Oil 2

sdd ts

t

d

t

ds

r)(

FV

r)(

FV

r)(

FVPV

111 2

2

1

1

.200 r

2st

11

td

70.14$sFV

2.10$ 2dFV

2 2dt

2.00$ 1dFV

221

2001

7014$

2001

102$

2001

002$

).(

.

).(

.

).(

.PVs 3313$ .PVs

?sPV

Stock Price

only estimate dividends constant dividend

• zero growth

constant dividend growth supernormal growth

• initially dividend growth is not consistent

• eventually settles down to constant growth

You don’t need to

estimate the sale price!

Stock Price

zero growth dividends if paid annually

r

dPV s r

cPV perpetuity

Stock Price

zero growth dividends if paid more frequently

suppose you expect $0.50 dividend every quarter 10% required return

What is rational price?

mrd

PVs

410.

50.0$sPV

Stock Price

constant growth dividends

suppose you expect $2 annual dividend 1 year from now 5% dividend growth

market requires 20% return

gr

cPV

1

perpetuity growing

gr

dPV

1

s

05.020.0

00.2$s PV

33.13$s PV

Stock Price

constant growth dividends

suppose just paid $2 annual dividend

you expect 5% dividend growth

market requires 20% return

gr

gdPV

11

s

05.020.0

05.0100.2$s

PV

Nonconstant Dividend Growth

expected 20% div in 1 yr 15% div in 2 yrs 5% per year from then on

What is current price?

...nddds PVPVPVPV321

Stock Price Sensitivity to g

$0

$100

$200

0% 5% 10% 15% 20%

d1=$2 r=20%

$0

$100

$200

0% 5% 10% 15% 20%

Stock Price Sensitivity to r

d1=$2 g=5%

“Market Requires”

similar company $10.50 current stock price $1.00 dividend just paid 5% expected annual div growth

What is required return?

gPV

dr

s

1