FIN3403 LECTURE GUNTER Monday October 6th 2014 1 Disclaimer These notes were prepared by a student enrolled in Melody Gunter s FIN3403 Fall 2014 course and were compiled for Exam 2 These notes contain all materials discussed during lecture on October 6th 2014 and aim to serve as a partial conceptual review for strictly Exam 2 Studying these notes alone will not guarantee you a passing grade It is highly recommended you combine the review of these notes with the review of notes from other lecture dates that you may have missed in addition to extensive practice using your TI BA II Plus on calculation problems Happy studying Just a quick review of previous concepts If a company has shares of stock outstanding and decides to build more capital in order to fund a new project the company can issue new stock or sell bonds o Some companies will sell convertible bonds in order to minimize the impact on existing shareholders who would have seen their shares immediately diluted o EPS or Earnings per Share is calculated by dividing net income by the amount of shares outstanding o Thus when new shares are issued EPS goes down denominator increases This is a disadvantage to current shareholders o To combat this problem companies will issue convertible bonds instead of new shares of stock to raise capital Recall convertible bonds from Sept 29th lecture Issuing convertible bonds removes that immediate dilution of EPS while allowing the company to raise capital at lower rates Features of Common Preferred Stock Shareholders owners It is rare that shareholders are also managers Stock gives shareholders the right to vote for material things such as board members Common stockholders have the right to o Share in whatever dividends the company decides to payout proportional to the amount of stock they own If you own 5 of outstanding shares and the company decides to payout 1 000 in dividends you would receive 5 of that which would be 50 o Share in whatever the liquidation value of the company is If the company ceases to be a going concern assets will be sold and debt holders liability holders will get paid first Whatever is left goes to common stockholders o Vote on acquisitions large investments management and other material or big deal things that may take place for the company o Pre emptive right the right to buy your proportional share of new shares being issued by the company before those new shares become available to the public 2 FIN3403 LECTURE GUNTER Monday October 6th 2014 If you already own 10 of a companies stock and the company decides to issue 1 000 new shares of common stock you would be given the option to buy your 10 or 100 shares before those new shares become available to non shareholders Common stockholders do not have the right to o Demand dividends from the company Net income can be paid out in the form of dividends to shareholders or it can be retained in equity as retained earnings and show up on the balance sheet Dividends are not tax deductible o Dividends paid to you are taxed as income to you Preferred Stock o Dividends are explicitly stated however they are not necessarily required to be paid each year o Sometimes a company may skip dividends for a year or two They will eventually be required to make up to the preferred stockholder what they have missed in dividend payments in later years however o If a company isn t paying their preferred dividends it is possible that the company isn t doing great financially Book Values Debt vs Equity The book value of debt usually equals the market value of that debt The book value of equity is a little more complicated o BV equity is made up of the PAR additional paid in capital APIC and retained earnings o Market value equity shares outstanding market price As a manager it is your goal to maximize stockholder wealth Stockholder wealth is represented by the market value of equity because the market value of that equity is the price at which an equity holder can transfer ownership of the company Value of a Share from the Shareholders Perspective The cash flows from a share of stock are made up of the dividends paid out and the market price that you may sell that share for later into the future Price PV dividends PV sale price Since stocks do not have a maturity date like that of bonds we can assume the term of a stock will go on indefinitely onto infinity o Thus we can treat a stock as a perpetuity in the most basic sense We will call Pt the price of the stock at a specified time so replace t with the period being referenced We will call Dt the dividend payment at a specified time so replace t appropriately Since we value stock in reference to the upcoming cash flows you will never consider dividend payments that have passed only dividend payments that are upcoming FIN3403 LECTURE GUNTER Monday October 6th 2014 3 Stock Valuation Models 1 Zero Growth Model a Example a company pays dividends of 2 00 a year and we expect this to continue forever the required rate of return is 10 This would be considered a simple perpetuity D1 So P0 r we use the dividend payment of period 1 instead of at period 0 because we assume the dividend at period 0 has already been paid and we NEVER consider past payments in the valuation of stock price P0 2 00 10 20 Similarly if you wanted to find the price of the stock in period 2 you would ignore the dividend payment in period 2 D2 and consider only the dividend payment in period 3 D3 Since we are dealing with a perpetuity in which we assume all dividend payments will be 2 00 forever D2 and D3 are the same so considering the D2 instead of D3 will not change the results under this model 2 Another stock valuation model a Example a company pays dividends of 2 00 a year with each year s dividend payment increasing by 5 from the previous year and will continue to follow this exact trend indefinitely the required rate of return in 10 This would be considered a growing perpetuity D0 2 00 D1 2 00 1 05 2 10 D5 2 00 1 05 5 2 55 D1 r g 2 10 10 05 42 b So P0 c Just remember to move the dividend forward 1 period from the period you re calculating the value for So if you re calculating P4 you would use the D5 in your growing perpetuity formula s numerator 3 Multi phase Growth Model a An example of this is posted on Bb under Week 7 of the Weekly Materials tab An important note Gunter will never tell us to calculate the present value of a stock using a particular model Don t focus on knowing the names of these models but
View Full Document
Unlocking...