FNCE 2P91: Corporate Finance-Notes-Chapter 8: Stock Valuation
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 15.02.11
FNCE 2P91: Corporate Finance-Notes-Chapter 8: Stock Valuation Notes Saturday, February 19 Quiz Two Bonds and Stocks Chapters 7 and 8 Lab 5 Stocks Chapter 8 Midterm th March 5 Saturday Up to and including today’s class Next Week Reading Week st
March 1 Two weeks from today Chapter 9 not on the midterm Review
BOOSTER JUICE EXAMPLE Instead of spending $7.29 per week on Booster Juice, an aspiring 2P91 student invests that money at an EAR of 8% every week for 4 years from age 18 to 22. Then he/she lets the savings compound until retirement at age 65. How much does the student have at age 65? EAR EWR
6% ?
Step One: How much have they saved at age 22? $7.29 annuity [ Step Two: Let the FV22 grow at the EAR of 6% for 43 years
]
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 REVIEW QUESTION Find the N value of an annuity formula You owe $5000 and have agreed to make $150 payments per month to lender. If the APR you are being charged is 6%, how many payments will you have to make? PV Payment r N
$5000 $150 ? [
]
REVIEW QUESTIONS FROM TEXT FOR MIDTERM
Chapter 7 7-3 7-4 7-14 7-16 7-24 7-26 7-30
Chapter 8 8-9 8-10 8-11 8-13 8-19 8-20
Chapter 6 6-11 6-13 6-14 6-29 6-33 6-39 6-59 6-69
BOND REVIEW Price of any Bond is going to be equal to the Present Value of Cash Flows For Example: We had a bond with 12% coupon rate and 30 years to maturity with a YTM of 12%. The face value is $1000. What is the price of the bond going to be? [
]
If YTM increases to 15% [
]
Interest Rate Risk Longer bonds will have more price movement that shorter bonds for same YTM impact
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Example Two Compare above 30 year bond to 2 year bond Coupon Rate 12% Maturity 2 years YTM 12% Face Value $1000 Price = $1000 Part Two: Question: If YTM increase to 15% Answer:
HOLDING PERIOD YIELD Try question 7-30 in the textbook Question: You just bought a 20 year bond with a 6% coupon rate for $894.06. Face value is $1000. What is the YTM? Answer: Option One: YTM will be less than 6%. Therefore bond is selling at discount. [
]
Solve for YTM Option Two: Estimate YTM [
̂
]
[
̂
]
Check: At 7% YTM [ Therefore, YTM is 7%
]
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Part Two: Question: Inflation has been creeping up over 5 years so that in 5 years the bonds YTM is now 9%. What is the price now? Answer: [
]
Part Three: Question: Boss tells you we need the money, sell it! What is the Holding Period Yield? Answer: [
]
Solve for HPY Trial and Error Try 5% So 5% is too high Try at 3.90% So HPY is 3.90%
Try question 7-30 for Holding Period Yield th If you have the 6 edition it is 7-27
CHAPTER 8: STOCK VALUATION Formula:
How do investors get paid? Bonds Coupons Face Value/Principle Repaid o Cash Flows are KNOWN o Length in years of terms Stocks Dividends Perpetual Cash Flow o Cash Flows are NOT known Stock Ownership Voting Rights (but not all stocks) Receive dividends o Paid out after tax earnings and managers decide on amount of dividend
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Example: Price CTC.A (Canadian Tire) RY (Royal Bank) RIM (Research in Motion) BCE (Bell Canada) GOOG (Google)
$63.40 $55.88 $64.56 $35.39 $625
Number of Shares Outstanding 78 Million 1.4 Billion 523 Million 755 Million 320 Million
Market Capitalization $5.8 Billion $80 Billion $34 Billion $27 Billion $200 Billion
Dividends ($) $1.10 $2.00 $0 $1.83 $0
Dividend Yield 1.7% 3.6% N/A 5.2% N/A
PAYOUT RATIOS what percent of earnings is paid out as dividends Royal Bank Example: Earnings per Share (EPS) Dividends per Share
$3.49 $2.00
So payout ratio
Canadian Tire Class A Example:
STOCK VALUATION Question: Mac Daddy Inc. just paid a dividend of $3.90 and plans to increase this dividend by 2% forever. So in investors require an 8% return. What is the expected price of the share? Main Model:
Answer:
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Part Two: What is the current year dividend yield and gain yield from
Therefore, gain yield is equal to 2% Therefore, dividend yield is 6% and require return is equal to 8% From
model we can determine expected price at any year
Question: What is expected price of Mac Daddy in 20 years? Answer: D1 D2 D21
3.90(1.02) 2 3.90(1.02) 21 3.90(1.02) = $5.91
So
QUESTION: th A firm is not expected to pay dividends for the next 5 years. At the end of the 6 year $6.10 will be paid and grow at 15% per year forever. If required return is 18% what is the stock price today?
0
1
Price at P5
In One Step
2
3
4
5
6 7 $6.10 $6.10(1.15)
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 TYPES OF SHARES Common Shares o Can be issued with or without voting rights Preferred Shares o Preferred access to the assets of the company in the event of a bankruptcy o Pay a fixed dividend o No dividends to common share holders until preferred holders get theirs o Mix of debt and equity For Example: Bank of Montreal (BMO) offers 6% preferred share on $100 par value. You require 8% return. How much would you pay for these shares? Answer: Perpetuity with no growth
BIG ENERGY Question: Big Energy just paid a dividend of $8.00 and expects to grow this amount by 4% per year forever. Your required return is 12%. What is the expected current price? Answer: D0 D1
$8.00 $8.00(1.04)
Part Two: Price in 10 years? D1 D11
8(1.04) 11 8(1.04) = 12.32
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Part Three: Big Energy announces oil find and expects dividends to grow by 8% after 10 years? What is new expected price? Answer:
g1 g2
0.04 0.08
D10 D11
8.00(1.04) 10 8.00(1.04) (1.08) = $12.789
10
g2
g1 [
(
) ]
EXAMPLE: FROM OLD MIDTERM Question: The Carleton Company has just paid a dividend of $2.00 per share which is expected to grow at 8% per year for the next 3 years and then 4% per year forever. Investors require a 12% for the next 3 years and then 9% per year forever. What is the fair price for the stock today? Answer: g1 G2 r1 r2
0.08 0.04 0.12 0.09
Step One: First calculate the dividends over high growth rate D1 2.00(1.08) = 2.16 2 D2 2.00(1.08) = 2.33 3 D3 2.00(1.08) = 2.52 After 3 years the growth rate declines to 4% and investors require 9%. So at P3 the price would be:
To determine stock price today take the PV of the 3 dividends and the expected future price. Teka into account r = 12% for the first 3 years
FNCE 2P91: Corporate Finance-Notes-Chapter 8: Stock Valuation Notes Saturday, February 19 Quiz Two Bonds and Stocks Chapters 7 and 8 Lab 5 Stocks Chapter 8 Midterm th March 5 Saturday Up to and including today’s class Next Week Reading Week st
March 1 Two weeks from today Chapter 9 not on the midterm Review
BOOSTER JUICE EXAMPLE Instead of spending $7.29 per week on Booster Juice, an aspiring 2P91 student invests that money at an EAR of 8% every week for 4 years from age 18 to 22. Then he/she lets the savings compound until retirement at age 65. How much does the student have at age 65? EAR EWR
6% ?
Step One: How much have they saved at age 22? $7.29 annuity [ Step Two: Let the FV22 grow at the EAR of 6% for 43 years
]
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 REVIEW QUESTION Find the N value of an annuity formula You owe $5000 and have agreed to make $150 payments per month to lender. If the APR you are being charged is 6%, how many payments will you have to make? PV Payment r N
$5000 $150 ? [
]
REVIEW QUESTIONS FROM TEXT FOR MIDTERM
Chapter 7 7-3 7-4 7-14 7-16 7-24 7-26 7-30
Chapter 8 8-9 8-10 8-11 8-13 8-19 8-20
Chapter 6 6-11 6-13 6-14 6-29 6-33 6-39 6-59 6-69
BOND REVIEW Price of any Bond is going to be equal to the Present Value of Cash Flows For Example: We had a bond with 12% coupon rate and 30 years to maturity with a YTM of 12%. The face value is $1000. What is the price of the bond going to be? [
]
If YTM increases to 15% [
]
Interest Rate Risk Longer bonds will have more price movement that shorter bonds for same YTM impact
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Example Two Compare above 30 year bond to 2 year bond Coupon Rate 12% Maturity 2 years YTM 12% Face Value $1000 Price = $1000 Part Two: Question: If YTM increase to 15% Answer:
HOLDING PERIOD YIELD Try question 7-30 in the textbook Question: You just bought a 20 year bond with a 6% coupon rate for $894.06. Face value is $1000. What is the YTM? Answer: Option One: YTM will be less than 6%. Therefore bond is selling at discount. [
]
Solve for YTM Option Two: Estimate YTM [
̂
]
[
̂
]
Check: At 7% YTM [ Therefore, YTM is 7%
]
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Part Two: Question: Inflation has been creeping up over 5 years so that in 5 years the bonds YTM is now 9%. What is the price now? Answer: [
]
Part Three: Question: Boss tells you we need the money, sell it! What is the Holding Period Yield? Answer: [
]
Solve for HPY Trial and Error Try 5% So 5% is too high Try at 3.90% So HPY is 3.90%
Try question 7-30 for Holding Period Yield th If you have the 6 edition it is 7-27
CHAPTER 8: STOCK VALUATION Formula:
How do investors get paid? Bonds Coupons Face Value/Principle Repaid o Cash Flows are KNOWN o Length in years of terms Stocks Dividends Perpetual Cash Flow o Cash Flows are NOT known Stock Ownership Voting Rights (but not all stocks) Receive dividends o Paid out after tax earnings and managers decide on amount of dividend
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Example: Price CTC.A (Canadian Tire) RY (Royal Bank) RIM (Research in Motion) BCE (Bell Canada) GOOG (Google)
$63.40 $55.88 $64.56 $35.39 $625
Number of Shares Outstanding 78 Million 1.4 Billion 523 Million 755 Million 320 Million
Market Capitalization $5.8 Billion $80 Billion $34 Billion $27 Billion $200 Billion
Dividends ($) $1.10 $2.00 $0 $1.83 $0
Dividend Yield 1.7% 3.6% N/A 5.2% N/A
PAYOUT RATIOS what percent of earnings is paid out as dividends Royal Bank Example: Earnings per Share (EPS) Dividends per Share
$3.49 $2.00
So payout ratio
Canadian Tire Class A Example:
STOCK VALUATION Question: Mac Daddy Inc. just paid a dividend of $3.90 and plans to increase this dividend by 2% forever. So in investors require an 8% return. What is the expected price of the share? Main Model:
Answer:
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Part Two: What is the current year dividend yield and gain yield from
Therefore, gain yield is equal to 2% Therefore, dividend yield is 6% and require return is equal to 8% From
model we can determine expected price at any year
Question: What is expected price of Mac Daddy in 20 years? Answer: D1 D2 D21
3.90(1.02) 2 3.90(1.02) 21 3.90(1.02) = $5.91
So
QUESTION: th A firm is not expected to pay dividends for the next 5 years. At the end of the 6 year $6.10 will be paid and grow at 15% per year forever. If required return is 18% what is the stock price today?
0
1
Price at P5
In One Step
2
3
4
5
6 7 $6.10 $6.10(1.15)
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 TYPES OF SHARES Common Shares o Can be issued with or without voting rights Preferred Shares o Preferred access to the assets of the company in the event of a bankruptcy o Pay a fixed dividend o No dividends to common share holders until preferred holders get theirs o Mix of debt and equity For Example: Bank of Montreal (BMO) offers 6% preferred share on $100 par value. You require 8% return. How much would you pay for these shares? Answer: Perpetuity with no growth
BIG ENERGY Question: Big Energy just paid a dividend of $8.00 and expects to grow this amount by 4% per year forever. Your required return is 12%. What is the expected current price? Answer: D0 D1
$8.00 $8.00(1.04)
Part Two: Price in 10 years? D1 D11
8(1.04) 11 8(1.04) = 12.32
FNCE 2P91 - Section 05 Winter 2011 - Duration 03 Part Three: Big Energy announces oil find and expects dividends to grow by 8% after 10 years? What is new expected price? Answer:
g1 g2
0.04 0.08
D10 D11
8.00(1.04) 10 8.00(1.04) (1.08) = $12.789
10
g2
g1 [
(
) ]
EXAMPLE: FROM OLD MIDTERM Question: The Carleton Company has just paid a dividend of $2.00 per share which is expected to grow at 8% per year for the next 3 years and then 4% per year forever. Investors require a 12% for the next 3 years and then 9% per year forever. What is the fair price for the stock today? Answer: g1 G2 r1 r2
0.08 0.04 0.12 0.09
Step One: First calculate the dividends over high growth rate D1 2.00(1.08) = 2.16 2 D2 2.00(1.08) = 2.33 3 D3 2.00(1.08) = 2.52 After 3 years the growth rate declines to 4% and investors require 9%. So at P3 the price would be:
To determine stock price today take the PV of the 3 dividends and the expected future price. Teka into account r = 12% for the first 3 years
