Valuation of Common Stock

 New

Stock sale occur in PRIMARY market. Exchange is SECONDARY market

 Stock

Concepts :
 Book

values values net proceeds minus

 Market

 Liquidation values

liabilities.

Going Concern Value

 Extra earning

power better use of assets.

 Intangible Assets

R&D Pfizer R&D $500M annually Future investments Microsoft offered stock in 1986 when assets were $73M while price paid on stock was $519M.

Market Value Balance Sheet

 ASSETS:

Assets in place Investment Opportunities LIABILITIES: Market value of debt & other obligations Market value of stockholders equity

Valuing Common Stock

 Consider

Cash Pay off:

Dividends Capital Gains or losses

Formula:
 Expected

Return = r r = DIV1 + P1 - P0 \ P0  Where:  P0 = Current Price  P1 = Expected Price in one year  DIV1 = Dividend

Example :
Skies stock selling at $75 ( P0 = $75 )  Dividend expected $3 ( DIV1 = $3 )  Expect to sell at $81 after one year (P1=$81)
 Blue

Answer:
r=

$3 + $81 - $75 \ $75  r = .12 or 12 %

Expected Return comes in two part :

Expected
 Expected

Expected

Return = Dividend + Capital Yield Appreciation

Example :
=

DIV1 \ P0 + P1 P0 \ P0  = $3 \ $75 + $81 - $75 \ $75  = .04 + .08  = .12 or 12 %

Market Value of Stock

 Market

value of STOCK is the PV of Cash Flows ( Exp. Div. + Exp. Price ) at expected return of comparable securities.

Formula :
 Price today


= P0

PO = DIV1 + P1 \ 1 + r

Example :
 P0 =

$3 + $81 \ 1.12  P0 = $75

Question :
 How

investors react if P0 more or less than $75?

Time for a class room assignment !

 You

purchase 100 shares of stock for $40 a share. The stock pays a $2 per share dividend at year end. What is the rate of return on your investment for these end of year stock prices? $35, $40, $45.  What is your real rate of return assuming inflation at 5 percent.