Professional Documents
Culture Documents
Lecture14 PDF
Lecture14 PDF
Management
Fall 2020
Farzad Saidi
Definition of equity:
• Issued by corporations
• Public: traded on exchange
• Private: closely held, including private equity
• Residual claim on company cash flow: limited liability
1
Common vs. preferred stock
Common stock:
Preferred stock:
• No voting rights
• Fixed dividend senior to common stock dividends
⇒ like a perpetuity (infinite lifetime bond)
• Embedded options: callable
2
Dividends
3
Models of equity valuation
4
Balance sheet methods
Liquidation value
5
Balance sheet methods
6
Required return
Expected return:
Cash dividends and capital gains or losses
E (D1 ) + (E (P1 ) − P0 )
E (r ) = E (HPR) =
P0
Required return or market capitalization rate:
According to the CAPM
k = rf + β (E (rM ) − rf )
E (r ) = k
7
Intrinsic value
Intrinsic value: V0
E (D1 ) + E (P1 )
V0 =
1+k
Remarks:
8
Example: intrinsic value
You expect the price of ABC stock to be $59.77 next year. Its current
market price is $50, and you expect the dividend next year to be $2.15
a) If the stock has a beta of 1.15, the risk-free rate is 6% per year and
the expected rate of return on the market portfolio is 14% per year,
what is the required rate of return on ABC?
b) What is the intrinsic value of ABC and how does it compare to the
current market price?
9
Dividend discount model
Assumption:
Assumption:
Example:
11
Microsoft dividends
0.45
0.4
0.35
0.3
in USD
0.25
0.2
0.15
0.1
0.05
Jan2005 Jul2007 Jan2010 Jul2012 Jan2015 Jul2017
Assumption:
Dt = Dt−1 × (1 + g ) = D0 × (1 + g )t
• Assume k > g :
D0 × (1 + g ) D1
V0 = =
k −g k −g
13
Examples
14
Multi-stage growth models
to yield:
T
X (1 + g1 )t 1 DT (1 + g2 )
V0 = D0 + ×
t=1
(1 + k)t (1 + k)T k − g2
15
Example
• D0 = $2.00
• k = 15%
• Growth g1 = 20% up to year T = 3 then slows to g2 = 5%
• What is the value of the company?
• Thus dividends are:
D1 = ......... D2 = . . . . . . . . .
D3 = ......... D4 = . . . . . . . . .
V0 = .........
16
Problem with the DDM
17
Equity repurchases vs. dividends
B. Larrain and M. Yogo: “Does firm value move too much to be justified
by subsequent changes in cash flow?” Journal of Financial Economics
(2008)
18
Possible solutions
19
So how do I value a company?
In theory:
• All valuation models should give you the same value if all
assumptions are right
In practice:
20
Summary
This class:
Next class:
• Price-earnings ratios
• Look at the aggregate stock market
21