Valuation of Bonds and Common StocksHow Common Stocks are TradedCommon Stock Price InformationEstimating the Cost of Equity CapitalExample – Cost of Equity Capital for GEAlternative Estimate of GrowthLinking Stock Price and EPSExample – Estimating PVGO for GENext ClassValuation of Bonds and Common Stocks•Bond Valuation•Stock Valuation•How Common Stocks are Traded•Estimating the Cost of Equity Capital•Linking Stock Price and Earnings per ShareHow Common Stocks are Traded•Primary market–New capital–Initial Public Offering (IPO)•Secondary market–Auction market•Specialists as market maker (NYSE)•Computer based (Tokyo)–Dealer market•Over-the-counter (OTC)•NasdaqCommon Stock Price Information•Wall Street Journal–Redesigned tables – largest 1500 stocks•Stock name•Symbol•Close•Net Change (daily)•Symbol for 52 week high or low•Online–finance.yahoo.com–Quote.com–www.nasdaq.com–moneycentral.msn.com./investorEstimating the Cost of Equity Capital•Let r = the cost of equity capital•Rearrange the perpetuity with a constant growth rate formula:grDIVP10gPDIVr 01Example – Cost of Equity Capital for GEwhere 1.12 is the forward annual dividend rate (Yahoo! Finance)36.19 is the current price 10% is the next 5 year growth estimate (Yahoo! Finance)%1.131.031.10.19.3612.101 gPDIVrAlternative Estimate of Growthg = Plowback ratio x ROEGE’s plowback ratio = 50% (Yahoo! Finance)GE’s ROE = 18.65% (Yahoo! Finance)g = .5 x .1865 = .093r = .031 + .093 = 12.4%Warning: Constant growth rates are not valid.In practice, need to vary growth rates.Linking Stock Price and EPSPresent value of growth opportunities (PVGO)PVGOrEPSP 10rEPSPPVGO10Example – Estimating PVGO for GE•Average earnings under a no growth policy, estimated as average of 2007 and 2007 (Est.)•2006 = 1.99, 2007 = 2.22, Average = 2.105•PVGO as a % of stock price = 55.6%131.105.219.3610rEPSPPVGO12.2007.1619.36 PVGONext Class•Using Net Present Value to Make Investment Decisions•Student presentations–Net Present Value–Internal Rate of Return•Read Chapters 5 and 6 in the
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