Finance 3101 Ch 9

Constant Growth Model

A stock whose dividends are expected to grow forever at a constant rate. ➢ If g > rs, the constant growth formula leads to a negative stock price, which does not make sense. Hence, the constant growth model can only be used if: • rs > g. • g is expected to be constant forever. The constant growth model can only be used if: a company's growth rate is expected to remain constant in the future. This condition almost never holds for new start-up firms, but it does exist for many mature companies. Indeed, mature firms such as Allied and GE are generally expected to grow at about the same rate as nominal gross domestic product (that is, real GDP plus inflation).

Non Constant Growth Model

Step 1: Calculate Dividends D_1 to D_(N+1) (N is the last year of the non-constant growth period, the Horizon Date.) Step 2: Calculate Horizon Value (P_N ) ̂ (Stock Price at the end of the Non Constant Growth Period) Step 3: Calculate (P_0 ) ̂ (Calculator's CF and NPV function can help you get PVs of dividends and Horizon Value. Inputs are 〖CF〗_1= D_1,〖〖CF〗_2= D_2,......,CF〗_N= D_N+(P_N ) ̂)

Discounted Dividend Model

Value of a stock is the present value of the future dividends expected to be generated by the stock.

Proxy

a document giving one person the authority to act for another, typically the power to vote shares of common stock.

Free Cash Flow

a measure of a company's financial performance, calculated as operating cash flow minus capital expenditures. FCF represents the cash that a company is able to generate after spending the money required to maintain or expand its asset base.

Annual Meeting

a meeting (as of the stockholders of a business concern) held annually for reviewing developments of the year just past, electing new officers, and voting on major organizational policies.

Intrinsic value

represents the "true" value of the company's stock, cannot be directly observed and must instead be estimated.

Stock Price

the current market price, and it is easily observed for publicly traded companies.

Corporate Valuation Model (free cash flow method)

the value of the entire firm equals the present value of the firm's free cash flows.

Drawbacks of Dividend Discount Model

• Some firms do not pay dividends. • Dividends are dependent on earnings; • A reliable dividend forecast must be based on an underlying forecast of the firm's future sales, costs, and capital requirements. • This recognition has led to an alternative Enterprise-Based stock valuation approach, the corporate valuation model.

Four Approaches for Estimating the Intrinsic Value of a Common Stock

➢ Discounted dividend model (Notes 9_1) ➢ Corporate valuation model (Notes 9_2) ➢ P/E multiple approach (Book page 323) ➢ EVA approach (Book page 323)

Preferred Stock

➢ Preferred Stock is a Hybrid security. ➢ Like bonds, preferred stock has a par value. Its fixed dividend must be paid before dividends can be paid on the common stocks. So, preferred stock is a perpetuity. ➢ However, companies can omit preferred dividend payments without fear of pushing the firm into bankruptcy. Skipping the payment will not lead to bankruptcy.