Valuation and Characteristics of Common Stocks.pptVIP

Valuation and Characteristics of Common Stocks Financial Management B 642 Outline What are stocks? Types of Stocks Preferred Stock Common Stock Characteristics of Preferred Stocks Characteristics of Common Stocks How to value a Preferred Stock? How to value a Common Stock? What is a Stock? Stocks represent ownership capital Stockholders are part owners of the company Types of Stocks Preferred Stocks A stock that enjoys preference over common stockholders in terms of payment of dividend and in terms of distribution of assets in case of liquidation of the firm A hybrid security Has features of both common stock and a bond Pays a fixed rate of dividend each year (like coupon on a bond) and Has infinite life (like common stock) Non payment of dividend does not bring bankruptcy Dividends cannot be deducted from firm’s income for tax purposes Cumulative Dividend How to value preferred stock? Present value of anticipated/expected cash flows when discounted at the required rate of return by the preferred stockholders What cash flows are anticipated by preferred stockholders? Dollar amount of dividend every year for an infinite time period Value of Preferred Stock = PV of anticipated dividend discounted at the required rate of return Examples Common Stocks Common Stock Common stockholders are the true owners of the company Entitled to dividend if and when declared by the board of directors Entitled to vote at the annual general meetings of the firm They have the last claim on the assets of the firm after paying off creditors and bond holders and preferred stockholders They are also residual owners How to value common stock? PV of expected cash flows for common stockholders when discounted at the required rate of return for the common stockholders What cash flows are expected by common stockholders? An unequal stream of dividends for each year Value of Common Stock = PV of dividends for common stock holders Simplifying Assumptions to Value Common Stock Zero Growth Mode