Session 8 - Stocks and their Valuation, Chapter 7

All page numbers are references to Corporate Finance: A Focused Approach 7th edition by Ehrhardt and Brigham (Cengage Learning, 2020)

Need to Absorb - The attributes of common stocks including the rights of shareholders, how to use the Constant Growth Model, how to value non-constant growth stocks, and the attributes and valuation of preferred stock.  You should also be able to apply the Free Cash Flow model of firm valuation, both constant and non-constant growth, to find the value of the firm and the value of shares of stock. On exams, this chapter almost always includes calculations to include a CAPM problem, a constant growth stock valuation problem, a non-constant growth valuation problem.  Stocks are valued as perpetuities; we have done very few perpetuity valuations to this point in the course.

Do not need to Absorb - Types of common stock in (7.2) and stock market reporting (7.3).  Due to space and time limitations, I will not ask for the in-depth analysis presented in Section 7.7.  I am unlikely to ask on exams about stock valuation using multiples (these are fair game for quizzes).

Need to Read - Read the Chapter.

Need to Do - Make 100 on the Quiz.  You should be able to answer almost all of the end of chapter questions and problems. Most of the end of chapter problems have been used on past quizzes and exams.  You need to continue to work with you financial calculator or spreadsheet.  You can find Simple and useful instructions for most calculators here and Excel instructions in the Chapter 7 Toolkit in D2L.

1. Watch the Chapter 7ﾠOverview video. The PowerPoints for all of this chapter’s videos are located here.
2. Read pages 295-299.  If you feel the need, watch the Stock Concepts (minicase, page 339, part a) video.
3. Read pages 299-307.  I suggest you watch the video on Constant Growth Free Cash Flow Model (minicase part b-e).  After this, you should be able to solve Problems Self-test 3 and Problems 2, 5, 11, and 14.
4. Read pages 307-323.  The video relating to these pages is the Non Constant Growth Free Cash Flow Model (minicase part f-m).  If you are personally interested how to value a firm and the drivers of value, this is a good video.  If you are mostly concerned with passing Exams, skip it.  After this video, you should be able to solve problems 3, 4, 12, 15-17, and 22.
5. Read pages 323-326 to learn about the Dividend Discount Model for Constant Growth Stocks.  I strongly suggest you watch the Stock Valuation Concepts and Constant Growth Model video.  This video covers at least two topics tested on any Exam that I create. After this video, you should be able to solve problems 6-8, 10, 11, 15-17, and 22.
6. Read pages 326-328 to learn about valuing Non-Constant Growth stocks.  I strongly suggest you watch the Non-Constant Dividend Growth Model video. After this video, you should be able to solve problems 9, 18, 19, and 24.
7. Read the rest of the Chapter.  If you feel the need, watch the video on the Market Multiple Valuation Method and Preferred Stock Valuation video.  Note, you can value preferred stock using the constant growth model by assuming growth is 0%.
8. Solve the remaining problems listed at the top of the page. You can find the solutions to these problems on our D2L page. If you need additional instruction, here are audio solutions to the most common types of stock valuation problems:
• Timeless Corporation issued preferred stock with a par value of $700. The stock promised to pay an annual dividend equal to 19.0% of the par value. If the appropriate discount rate for this stock is 10.0%, what is the value of the stock? | Audio Solution
• Forever, Inc's preferred stock has a par value of $1,000 and a dividend equal to 13.0% of the par value. The stock is currently selling for $907.00. What discount rate is being used to value the stock? | Audio Solution
• Here and After Corporation plans a new issue of preferred stock. Similar risk stock currently offers an annual return to investors of 17.0%. The company wants the stock to sell for $569.00 per share. What annual dividend must the company offer? | Audio Solution
• You are considering buying common stock in Grow On, Inc. The firm yesterday paid a dividend of $5.20. You have projected that dividends will grow at a rate of 8.0% per year indefinitely. If you want an annual return of 20.0%, what is the most you should pay for the stock now? | Audio Solution
• You are considering buying common stock in Grow On, Inc. You have projected that the next dividend the company will pay will equal $4.00 and that dividends will grow at a rate of 5.0% per year thereafter. If you would want an annual return of 13.0% to invest in this stock, what is the most you should pay for the stock now? | Audio Solution
• Growing, Inc. is a firm that is experiencing rapid growth. The firm yesterday paid a dividend of $7.50. You believe that dividends will grow at a rate of 24.0% per year for two years, and then at a rate of 5.0% per year thereafter. You expect an annual rate of return of 18.0% on this investment. If you plan to hold the stock indefinitely, what is the most you would pay for the stock now? | Audio Solution
• Growing, Inc. is a firm that is experiencing rapid growth. The firm yesterday paid a dividend of $5.60. You believe that dividends will grow at a rate of 24.0% per year for three years, and then at a rate of 10.0% per year thereafter. You expect an annual rate of return of 18.0% on this investment. If you plan to hold the stock indefinitely, what is the most you would pay for the stock now? | Audio Solution
• Growing, Inc. is a firm that is experiencing rapid growth. The firm yesterday paid a dividend of $8.00. You believe that dividends will grow at a rate of 22.0% per year for years one and two, 15.0% per year for years three and four, and then at a rate of 9.0% per year thereafter. If you expect an annual rate of return of 21.0% on this investment, what is the most you would pay for the stock now? | Audio Solution
• You are considering buying common stock in Grow On, Inc. The firm yesterday paid a dividend of $4.70. You have projected that dividends will grow at a rate of 6.0% per year indefinitely. The firm's beta is 2.39, the risk-free rate is 4.0%, and the market return is 10.9%. What is the most you should pay for the stock now?  | Audio Solution
• You are considering buying common stock in Grow On, Inc. You have calculated that the firm's free cash flow was $8.10 million last year. You project that free cash flow will grow at a rate of 6.0% per year indefinitely. The firm currently has outstanding debt and preferred stock with a total market value of $9.22 million. The firm has 1.20 million shares of common stock outstanding. If the firm's cost of capital is 25.0%, what is the most you should pay per share for the stock now? | Audio Solution
• You are considering buying common stock in Super Growth, Inc. You have calculated that the firm's free cash flow was $6.20 million last year. You project that free cash flow will grow at a rate of 20.0% per year for the next three years, and then 6.0% per year indefinitely thereafter. The firm currently has outstanding debt and preferred stock with a total market value of $26.60 million. The firm has 1.68 million shares of common stock outstanding. If the firm's cost of capital is 19.0%, what is the most you should pay per share for the stock now? | Audio Solution
9. Be prepared for a 60 minute quiz, with roughly 14 questions. The name of the  quiz is Chapter 7.

updated September 18, 2020