The Islamia University of Bahawalpur

Department of Management Sciences

Stock & Stock Valuation

Dr. AMNA NOOR
 The Islamia University of Bahawalpur
Department of Management Sciences

Question:
A company currently pays a dividend of $2 per share
(D0 = $2). It is estimated that the company’s dividend
will grow at a rate of 20% per year for the next 2
years, then at a constant rate of 7% thereafter. The
required rate of return on the stock, rs, is 12.3%. What
is your estimate of the stock’s current price?
 The Islamia University of Bahawalpur
Department of Management Sciences

2) Corporate Value Model

• Also called the free cash flow method. Suggests the value of
the entire firm equals the present value of the firm’s free cash
flows.
• Remember, free cash flow is the firm’s after-tax operating
income less the net capital investment
• FCF = NOPAT – Net capital investment
 The Islamia University of Bahawalpur
Department of Management Sciences

• The free cash flow valuation model estimates the value of the entire
company and uses the cost of capital as the discount rate.
• As a result, the value of the firm’s debt and preferred stock must be
subtracted from the value of the company to estimate the value of
equity.

MV of equity = MV of firm – (MV of debt + MV of Preferred share)

 The Islamia University of Bahawalpur
Department of Management Sciences

3) Corporate Multiples:

Three steps are necessary to project key financial variables into the future:
Step 1: Forecast future sales & profits
Step 2: Forecast future EPS and dividends
Step 3: Forecast future stock price
 The Islamia University of Bahawalpur
Department of Management Sciences

Step 1: Forecast future sales & profits

Example: Assume last year’s sales were $100 million,

sales growth is estimated at 8% and the net profit
margin is expected to be 6%.
 The Islamia University of Bahawalpur
Department of Management Sciences

Step 2: Forecast future EPS and dividends

Example: Assume estimated profits are $6.5 million, 2

million shares of common stock are outstanding, and the
dividend payout ratio is estimated at 40%.
 The Islamia University of Bahawalpur
Department of Management Sciences

Step 3: Forecast future stock price

Example: Assume estimated EPS are $3.25 and the estimated P/E
ratio is 17.5 times.
 The Islamia University of Bahawalpur
Department of Management Sciences

Other Multiple Approaches:

 The Islamia University of Bahawalpur
Department of Management Sciences

Features of Preferred Stock

• Ownership/Participating Preferred Stock
• Par Value/Face Value
• Maturity Date/value
• Fixed Dividend
• Cumulative Preferred Stock
• Callable Preferred Stock
• Convertible Preferred Stock
• Voting Rights
 The Islamia University of Bahawalpur
Department of Management Sciences

Preferred Stock Valuation

Several years ago, Rolen Riders issued preferred stock with a

stated annual dividend of 10% of its $100 par value. Preferred
stock of this type currently yields 8%. Assume dividends are
paid annually. What is the value of Rolen’s preferred stock?