StockValuation

PreparedBy: WaelShamsEL-Din

StocksandStockValuation
TypeofStocks
PreferredStocks

CommonStocks

PreferredStock
Preferred stock isaHybrid;it is similar to bonds
in some respects and to common stock in others.
Preferred stock has a par value and a fixed amount
of dividends that must be paid before dividends
can be paid on the common stock.
Despite Preferred Stock has a fixed payment like
bonds however a failure to make this payment will
not lead to bankruptcy.
The holder of the Preferred Stocks does not have
the voting right like the holder of the common
stock.

ValueofPreferredStock
The Value of Preferred Stock depend
on 2 factors:The

amount of annual dividends ( which is

fixed amount according to fixed rate)

The

required rate of return which is function

of ( RFR + Risk premium)

Value(PS)=Dividends
RRR

Example(1)
A preferred stock $10 par value, 10%
dividend (this amount is fixed) what is the
value of the share if the required rate of
return is equal 11%.
Answer
Value=Dividends
RRR
ValuePS= 10X10% = 1 = $ 9.09
0.11
0.11

Fee Founders Has

Example(2)

Preferred Stock Outstanding

Which Pays A Dividend Of $5 At The End Of Each
Year. The Preferred Stock Sells For $60 A Share.
What Is the Preferred Stocks Required Rate of
Return?
Answer
Value=Dividends
RRR
60= $5 =
RRR

RRR = 5 X100 = 8.33%

60

Example(3)
What will be the nominal rate of return on a
Preferred Stock with a $100 par value, a
stated dividend of 8 percent of par, and a
current market price of (a) $60, (b) $80, (c)
$100, and (d) $140?
Answer
Dividend = 100x8% = $8
Value=Dividends
RRR

RequiredRateofReturn
A) - RRR @ $60 =

8 X 100 =
60
B) - RRR @ $80 = 8 X 100 =
80
C) - RRR @ $100 = 8 X 100 =
100
D) - RRR @ $140 = 8 X 100 =
140

13.33%
10%
8%
5.71 %

Ezzell
Corporation
issued
preferred
stock
Example(4)
with a stated dividend of 10 % of par.
Preferred stock of this type currently yields
8% & the par value is $100. Assume
dividends are paid annually.
A. What is the value of Ezzells preferred
stock?
[Link] interest rate levels rise to the point
where the preferred stock now yields 12
percent. What would be the value of Ezzells
preferred stock?

Answer
Dividend = 100x 10% = $ 10
Value =
P=

P=

Dividends
RRR
10 = $ 125
0.08
10
0.12

= $ 83.33

The Problem of a common stock is that the

CommonStocks
amount of dividends, earning or cash flow
of return is not fixed and there is no
maturity, therefore we need to set several
assumptions related to the holding period of
the investment and cash flow that we may
receive during that period.
1) The Holding Period is one year
2) The Holding Period is more than one year
3) The Holding Period is unknown

TheHoldingPeriodisoneyear
The cash that may be received at
the end of the year is known as
dividend and selling price of that
stock will be at the end of same
year.

Example(5)
XYZ Company has a share that is
expecting to pay $1 dividend next
year and to be sold at $30 by the
end of that year, what is the value
of XYZ stock if the required rate of
return is 14%.

Answer
Today

FV
Price (PV) =

Price (PV) =

Dividend (D1)= $ 1
Selling Price = $ 30
--------$ 31
FV
1+RRR
31 = $ 27.19
1.14

TheHoldingPeriodismore
In this case we need to estimate
thanoneyear
dividends for the next years also the
expected growth rate in that dividends
during the coming holding period and
the selling price at the end of that
period.

Example(6)
ABCs share is expecting to pay $2
dividend next year while the dividends
of this stock will grow by 10% each
year, ABC Share is expected to be sold
at the end of 3 years for amount of $40,
what is the value of ABC stock if the
required rate of return is 14%.

Answer
Y0
Dividend

Y1

Y2

2.20

10%

10%

Selling Price
Total

Y3
2.42

40
2

2.20

42.42

Answer
Price (PV) = 2 + 2.20 + 42.42
1.14 1.142 1.143
Price(PV)= 1.7544+ 1.6928 + 28.6331=
Price ( PV) = $ 32.08

TheHoldingPeriodisunknown

In this case the company will be in the

mature stage then it will enjoy a constant
growth rate.
Example(7)
ABCs Share is expecting to Pay $ 3
dividends next year while it is expected to
have a constant growth rate for 5 %, what is
the value of ABC Stock if the required rate
of return is 15%.

Answer
Value =

Dividends
RRR- g

P0 =

D1
RRR-g
g Growth Rate
P=
3
0.15-0.05

= $ 30

ABCs share
Example(8)

is expecting to pay $ 2
dividends next year while it is expected to
have a constant growth rate for 10 %
annually for the coming 2 years then it will
fall to 4 % constantly, what is the value of
ABC stock if the required rate of return is
14%.

Answer
Y
Y1
0

Dividend

Y2
2.20

Y3
2.42
4%

10%
10%

Selling
Price
Total

25.20
2

2.20

27.62

Y4
2.52
Constant Growth

Answer
P3 =

D4
RRR- g
P3 = 2.52
= $ 25.20
0.14-0.04
Price (PV) = 2 + 2.20 + 27.62
1.14 1.142 1.143
Price (PV) = 1.75+ 1.69 + 18.64 = $ 22.08

Variables&Relationshipthataffectthe
Valueofcommonstock
P0 = D1
RRR-g

Variables
D1 Dividend which is affected by level of earning
RRR Required rate of return which is affected by
(Risk free rate + Risk Premium)
g Growth rate which is affected by payout ratio &
earning

Relationship
There is positive relationship between
dividend and value.
There

is negative relationship between

required rate of return and value.

There

is a positive relationship between

growth rate and value

GrowthRate(g)
g
Retention Rate (RR) X

ROE

(1-PayoutRatio)XNetIncome
Equity

Example(9)

Item
Amount
Sales
$100 Million
Cost of Goods Sold (COGS)
$ 50 Million
Book Value of ABC Share
$ 10
Interest rate on Cos Debt
15%
Tax Rate
40%
Amount Of Debt
$ 40 Million
No. of outstanding Shares
4 Million Shares
Risk Free Rate
10%
Market Risk Premium
25%
Beta
1.20
Payout Ratio
40%
The company is Financed by 50% Debt & 50% Equity

Example9
From the given data, Please find the
following:The Required Rate of Return
What is the Stock Value?

Answer
P 0 = D1
RRR-g
RRR= RFR + (Market Risk Premium) x Beta
RRR = 10% + (25% )X 1.20 = 40%
In order to get the stock value we need to
calculate g & D1

Answer
Sales

100,000,000

(-)COGS

50,000,000

EBIT
(-) Interest (40,000,000 X 15% )
EBT
(-) Tax @ 40%
NetIncomeAfterTax

50,000,000
(-)6,000,000
44,000,000
(-)17,600,000
26,400,000

RetentionRate(60%)PayOutRatio(40%)
15,840,000
10,560,000
4,000,000Shares
Dividend(D0)=2.64

Answer
g = RR X ROE
ROE = Net Income X 100
Equity
ROE = 26, 400, 0000 X100 =
40,000,000
g = RR X ROE
g = 60% x 66% = 39.60%
D1 = D0 X (1+g)
D1 = 2.64 X (1.3960) = 3.69

66%

Answer
P0 = D1
RRR-g
D1
= 3.69
RRR
= 40%
g
= 39.60%
P0 =
3.99
= 3.69 = $ 92.25
0.4000- 0.3960 0.004

Example10:10,000,000Units

SalesVolumeinUnits
SellingPriceperUnit

:$3

VariableCostperUnit :$1
TotalFixedCost
FixedAssets

:$1,000,000

:$2,000,000

DepreciationRateofFixedAssets:5%PerAnnum
RiskFreeRate(RFR)

:12%

MarketRequiredRateofReturn:20%
Beta

:1.20

LongTermDebt

:$5,000,000@InterestRate15%

NumberofOutstandingShares :1,000,000Shares
SharePrice(BookValue)
TaxRate

:35%

PayoutRatio

:50%

:$30

FromthementionedData,Find
1. Sales Revenue in Dollars
theFollowing:-
2. Total cost COGS= (Variable + Fixed + Depreciations)
3.
4.
5.
6.
7.
8.
9.
10.

Earnings Before Interest and tax (EBIT)

Retune on Equity (ROE)
Required Rate of Return (RRR)
Dividend for Current Year (D0)
Calculate Growth Rate (g)
Dividend For Next Year (D1)
Find the Value of ABC Share
If Share is traded in the stock Market at $250, what is your
decision as investor and why?

Answer
RRR= RFR + ( RM - RFR) x Beta
RRR = 12+ (20-12)1.20 = 21.60%
Sales = no. of units X Selling Price
Sales = 10 Million X3 = 30 Million
Variable Cost = No. of Units X Variable cost Per Unit
Variable Cost = 10 Million X 1 = 10Million
Depreciation = Fixed Assets X Deprecation Rate
Depreciation = 2Million X 5% = 100,000

Answer
Total cost COGS= (Variable + Fixed Cost + Depreciations)
COGS=10M+1M+100,000 = 11,100,000

Sales
30,000,000
(-) COGS
11,100,000
EBIT
18,900,000
(-) Interest (5,000,000 X 15% ) 750,000
EBT
18,150,000
(-) Tax @ 35%
6,352,500
NetIncomeAfterTax
11,797,500

Answer
NetIncome=

11,797,500

Retention Rate (50%)

Pay Out Ratio (50%)
5,898,750
5,898,750
1,000,000 Shares
Dividend D0 = 5.90
ROE = Net Income X 100
Equity
Equity = 1,000,000 X 30 = 30,000,000
ROE = 11, 797, 0000 X100 = 39.32%
30,000,000

Answer
g = RR X ROE
g = 50% x 39.32% = 19.66%
D1 = D0 X (1+g)
D1 = 5.90 X (1.1966) = 7.06
P0 = D1
RRR-g
D1
= 7.06
RRR
= 21.60%
g
= 19.66%

Answer
P0 =
7.06 = 7.06
= $ 363.92
0.2160- 0.1966 0.0194
Since the Fair value of the stock is
approximately is $364 while it is traded at
$250 ( Under Price) , Therefore my decision
as investor is to purchase stock as its has a
potential to move up to $ 364 and achieve
capital gain .

Thank You