A1 Business and Technical College Risk Return and Valuation Paper download the files down below andfollow all the steps pleasethank you>>>>>>>>>>>>>>>>>>>>

A1 Business and Technical College Risk Return and Valuation Paper download the files down below andfollow all the steps pleasethank you>>>>>>>>>>>>>>>>>>>>>>>> CHAPTER 7
STOCKS (EQUITY)—
CHARACTERISTICS
AND VALUATION
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1
Learning Outcomes
LO.1 Explain what equity is, and identify some of
the features and characteristics of (a)
preferred stock and (b) common stock.
LO.2 Describe how stock prices (values) are
determined when (a) dividends grow at a
constant rate and (b) dividend growth is
nonconstant.
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2
Learning Outcomes (cont.)
LO.3 Describe some approaches (techniques)
other than strict application of time value of
money models that investors use to value
stocks.
LO.4 Identify factors that affect stock prices.
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
3
Types of Equity (Stock)
? Preferred Stock: hybrid security
?
?
Similar to bonds with fixed dividend payments.
Similar to common stock because dividends are
not required to be paid and there is no specified
maturity date.
? Common Stock
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4
Preferred Stock Features
? Par Value
?
The nominal or face value of a stock or bond.
? Cumulative Dividends
?
Any preferred dividends not paid in previous
periods must be paid before common dividends
can be distributed.
? Maturity
?
Has no specific maturity date.
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5
Preferred Stock Features (cont.)
? Priority to Assets and Earnings
?
?
Preferred dividends are paid after interest on debt
is paid.
Preferred dividends must be paid before common
stock dividends are paid.
? Control of the Firm (Voting Rights)
?
Almost all preferred stock is nonvoting stock.
? Convertibility
?
Preferred stock that can be converted to common
stock at the option of the investor.
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6
Preferred Stock Features (cont.)
? Other Provisions
?
?
?
Call provision—gives the issuing corporation the
right to call in the preferred stock for redemption.
Sinking fund—calls for the repurchase and
retirement of a given percentage of the preferred
stock at particular times
Participating—shares (participates) with common
stockholders in the distribution of the firm’s
earnings.
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7
Common Stock Features
? Par Value
?
Legally, represents a stockholder’s minimum
financial obligation in the event the corporation is
liquidated.
? Dividends
?
The firm has no legal obligation to pay common
stock dividends.
? Maturity
?
Generally has no specific maturity date.
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8
Common Stock Features (cont.)
? Priority to Assets and Earnings
?
Dividends can be paid only after interest on debt
and preferred dividends are paid.
? Control of the Firm (Voting Rights)
?
Common stockholders have the right to elect the
firm’s directors and to vote on various proposals
? Preemptive Right
?
Gives stockholders the right to purchase additional
shares of stock sold by the firm on a pro rata basis
before the shares can be offered to new investors.
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
9
Types of Common Stock
? Classified Stock
?
Common stock that is given a special designation,
such as Class A, Class B, etc., to meet special
needs of the company.
? Founder’s Shares
?
A class of stock owned by the firm’s founders
who have sole voting rights in the early years
after going public.
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
10
Equity Instruments in International
Markets
? American Depository Receipts
?
Certificates created by banks that represent
ownership in stocks of foreign countries.
? Foreign Equity
?
?
Yankee stock—stock of a foreign company
traded in the United States.
Euro stock—stock traded in a country other
than the company’s home country, except in the
United States.
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
11
Stock Valuation Models—Terms
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
12
Stock Valuation Models—Terms
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
13
Stock Valuation Models—Terms
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
14
Expected Dividends as the Basis for Stock
Values—Cash Flow Timeline
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15
Expected Dividends as the Basis for
Stock Values
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16
Valuing Stocks with
Constant, or Normal, Growth
? Growth that is expected to continue into the
foreseeable future at about the same rate as that
of the economy as a whole.
? g = constant growth stated as a decimal
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17
Valuing Stocks with Constant, or
Normal, Growth (g)
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18
Present Value of Dividends of a Constant
Growth Stock: D0 = $1.60, g = 5%, rs = 20%
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19
Special Case of Constant Growth: g =
0
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20
Expected Rate of Return on a Constant
Growth Stock
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21
Valuing Stocks with Nonconstant
Growth
? Nonconstant Growth: The part of the life cycle
of a firm in which its growth is either much
faster or much slower than that of the economy
as a whole.
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22
Valuing Stocks with Nonconstant
Growth—Step 1
? Start computing the dividends that are expected
to be paid during the nonconstant growth period.
? Continue computing dividends until you compute
the last dividend that is affected by nonconstant
growth.
? Using the investors’ required rate of return, rs,
compute the present values of all the nonconstant
growth dividends, and then sum the present
values.
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23
Valuing Stocks with Nonconstant
Growth—Step 2
? Compute the first dividend that is affected by the
constant growth rate.
? Use the first “constant growth dividend” to compute
the value of the stock at the end of the nonconstant
growth period; all future dividends will grow at a
constant rate, gnorm.
? A modified version of the constant growth equation
is used to compute the value of the stock at the end
of the nonconstant growth period, P?.t
? Find the PV of P?t .
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
24
Valuing Stocks with Nonconstant
Growth—Step 3
? Sum the results of Step 1 and Step 2 to find the
intrinsic value of the stock, P?0 .
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
25
Valuing Stocks with Nonconstant
Growth—Example
? Dividends will grow at a 20 percent rate for the
next three (3) years; i.e., g1 = g2 = g3 = 20%.
? Beginning in Year 4, dividends will grow at a 5
percent rate, which will continue for the rest of
the firm’s life; i.e., g4 = … = g? = 5% = gnorm.
? Last dividend paid was $1; i.e., D0 = $1.00.
? rs = 15%
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
26
Valuing Stocks with Nonconstant
Growth—Example: Step 1
o Compute nonconstant growth dividends:
? Compute PV of nonconstant growth dividends:
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27
Valuing Stocks with Nonconstant
Growth—Example: Step 2
o Compute the first constant growth dividend:
o Compute the PV of P?3 :
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28
Valuing Stocks with Nonconstant
Growth—Example: Step 3
o Sum the results of Step 1 and Step 2 to find the
intrinsic value of the stock:
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
29
Other Stock Valuation Models
? P/E Ratios
?
?
The higher the P/E ratio the more investors are
willing to pay for each dollar earned by the firm.
P/E ratio gives an indication of a stock’s “payback
period.”
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
30
Other Stock Valuation Models
? Economic Value Added Approach
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31
Changes in Stock Prices
? Prices move opposite to changes in rates of
return.
? Prices move in the same direction as changes in
cash flows expected from the stock in the
future.
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
32
CHAPTER 8
RISK AND RATES OF
RETURN
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1
Learning Outcomes
LO.1 Explain what it means to take risks when
investing.
LO.2 Compute the risk and return of an
investment, and explain how the risk and
return of an investment are related.
LO.3 Identify relevant and irrelevant risk, and
explain how irrelevant risk can be reduced.
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2
Learning Outcomes (cont.)
LO.4 Describe how to determine the appropriate
reward—that is, rate of return—that investors
should earn for purchasing an investment.
LO.5 Describe actions that investors take when the
return they require to purchase an investment is
different from the return they expect the
investment to produce.
LO.5 Identify different types of risk, and classify each
as relevant or irrelevant with respect to
determining an investment’s required rate of
return.
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
3
Defining and Measuring Risk
? Risk is the chance that an unexpected outcome
will occur.
? A probability distribution is a listing of all
possible outcomes with a probability assigned
to each.
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4
Probability Distributions
? It either will rain, or it will not rain; there are
only two possible outcomes.
Outcome
Rain
No Rain
Probability
0.40
= 40%
0.60
= 60%
1.00
100%
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5
Probability Distributions
? Martin Products and U. S. Electric
State of the
Economy
Boom
Normal
Recession
Probability of This
State Occurring
0.2
0.5
0.3
1.0
Rate of Return on Stock if
the Economic State Occurs
Martin Prod. U.S. Electric
110%
20%
22
16
–60
10
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
6
Expected Rate of Return
? Rate of return expected to be realized from an
investment during its life.
? Mean value of the probability distribution of
possible returns.
? Weighted average of the outcomes, where the
weights are the probabilities.
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
7
Expected Rate of Return
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8
Total Risk (Stand-Alone Risk):
The Standard Deviation (?)
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9
Standard Deviation (?):
Martin Products
ri – r?
= (3)
(ri – r? )2
(4)
110% – 15% = 95
22 – 15 = 7
–60 – 15 = –75
9,025
49
5,625
ri
r?
(1) – (2)
(5)
(ri – r? )2Pri
(4) x (5) =
0.2 9,025 x 0.2
0.5
49 x 0.5
0.3 5,625 x 0.3
Variance = ?2
(6)
= 1,805.0
=
24.5
= 1,687.5
= 3,517.0
Standard deviation = ? =
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10
Estimated Standard Deviation, s
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