Chapter 7 Valuation and Characteristics of Stock

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Chapter 7 Valuation and Characteristics of
Stock

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Aim

• 1.     Identify the basic characteristics and
  features of ferret stock.
• 2.     Value preferred stock
• 3.     Identify the characteristics and features
  of common stock
• 4.      Value common stock
• 5 Calculate a stocks expected rate of
  return

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Terms

• Preferred Stock
• Common Stock
• The Stock Holders Expected Rate of Return
• Call provision
• Convertible Preferred Stock
• Cumulative Feature

• Cumulative Voting
• Expected Rate of Return
• Internal Growth
• Limited Liability
• Majority Voting
• Multiple-holding Period
• Preemptive Right
• Protective Provisions
• Proxy
• Proxy Fight
• Sink-fund Provision
• Valuation Model

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Preferred stock

• Hybrid security
• No fixed maturity date.
• Nonpayment of dividends leads no bankruptcy.
• Taxable
• Limited in amount.

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Multiple classes

• More than one series or class
• Each different characteristics. 13
• Priority status regarding assets in bankruptcy.
• No residual earning

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Example

• Par 25
• Dividend rate 7.56
• Dividend 1.89

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• l         Cumulative feature
• l         Protective provisions
• l         Convertibility
• l         Retirement Features
• l         Callable Preferred
• l         Sinking-Fund Provisions

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Cumulative feature

• Past unpaid be paid before common stock
  dividends declared.
• No dividend enforcement.

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Claims on assets and incomes

• Priority over common stock.
• Bonds gt preferred stock
• Preferred stock safer gt common stock
• Common stock.

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Protective provisions

• Restrict the payment of common stock.
• Voting right in case of nonpayment.
• (six quarterly dividends in arreas.
• Sinking funds

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Convertibility

• At discretion(???)predetermined shares.
• 1/3 convertibility feature.
• Reduced the cost of common stock.

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Retirement feature

• Take advantage of falling interest rates.
• Call provision repurchase at stated price.
• Initial premium above the par 10.
• Sinking fund provision set a maturity date.

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Common stock
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OBJECTIVE 3 COMMON STOCK

• Common stock is certificate that indicates
  ownership in the corporation.
• Features or Characteristic of Common Stock
• Claim on income
• Claim on Assets
• Voting Rights
• Preemptive Rights
• Limited Liability

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Claim on income

• Residual income to shareholders
• nothing if after bondholders
• Reinvestment earning power (capital gains)
• Limitless return
• Nothing

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52 WEEK YLD VOL
NET HI LO STOCK SYM DIV
PE 100s HI LO CLOSE CHG
GenElec GE 2.08 2.0 24 28140
GenGrowProp GGP 1.72 5.5 14 1498
GenHost GH dd 439
GenHouse GHW 0.32 3.1 dd
65 GenlnstrCp GIC dd
7091 GenMills GIS 2.00 2.9
24 5591 GenMotor GM 2.00f
3.5 10 29880
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Voting

• Voting directors of board
• Voting for the charter changes
• Proxy fight when takeover
• Majority vote
• Cumulative vote minority shareholders.

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Cumulative vote

• Outstanding 1 000
• Majority control749
• Minority control 251
• Election of board of directors?

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formula

• NE O x D/TN 1
• NE number of shares needed to elect a certain
  number of directors.
• O total number of shares of common stock
• outstanding.
• D number of directors desired.
• TN total number of directors to be elected.

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D 1,2 and 3

• (1000 x 1)/(3 1) 1 251
• (1000 x 2)/(3 1) 1 501
• (1000 x 3)/(3 1) 1 751

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Preemptive right

• Preemptive right entitles the common shareholder
  to maintain a proportionate share of ownership in
  the firm when issuing new stocks.
• Dilution of ownership

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Limited liability

• Liability limited in case of bankruptch to
  investment.
• Help raising the funds or debt.

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Common Stock ValuationSingle Holding Period
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• at the beginning of this year.
• Dividend1.64,
• market priceprojected 22.
• required rate of return18
• Value ?
• Vcs 1.64/(10.18) 22/(10.18)
• 1.3918.64
• 20.03

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OBJECTIVE 4 Valuing Common Stock

• g ROE r
• g the growth rate of future earnings and
  the growth in the common stockholders investment
  in the firm
• ROE the return on equity (net
  income/common book value)
• r the company's percentage of profits retained,
  called the profit-retention rate6
• g160.254

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Axiom

• Axiom 1 The Risk-Return Trade-off We Won't
  Take on Additional Risk Unless We Expect to Be
  Compensated with additional Return.
• Axiom 2 The Time Value of MoneyA Dollar
  Received Today is Worth More Than A Dollar
  Received in the Future.
• Axiom 3 CashNot Profitsis King.

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multiple-holding-period valuation model
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• Dividend 2
• growth rate 10
• Required rate of return 15
• D1D0(1g)2(10.10)2.20
• VcsD1/(kcs-g)
• 2.20/(0.15-0.10)44

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OBJECTICVE 5 The Stockholders Expected Rate of
Return
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K1psD/Pps 3.64/507.28
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The Common Stockholder's Expected Rate of Return
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• kcs 2.20 / 44 10 15

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Quiz

• Why would a preferred stockholder want the stock
  to have a cumulative dividend feature and
  protective provisions?