CH 3

Chapter Three
Bond and Stock Valuation
12/05/2023
Introduction
Corporations, big and small, need capital to do their
business.
Capital comes in two forms: debt capital and equity
capital.
To raise debt capital the companies sell bonds to the
public which obligated to pay interest
To raise equity capital the corporation sells the stock of
the company and the stockholders become owners and
have the right to receive a certain portion of any
Bond Valuation
Bonds are long-term source of borrowing which represents
a contractual agreement between the corporation and the
bondholders
A Company issued bonds when it wants to raise large sum

of money from the public at large.
The Company or the borrower issued this bond to pay its

holder a predetermined and fixed amount of interest each
period plus the principal at the end of the term or maturity.
Cont…….
Typically, a bond has the following features:
Par Value: is the price at which the bond will be redeemed
by the issuing company
Coupon Interest Rate: a specified amount of interest paid
each year to the holder by the borrower
Maturity Date: The length of time the bond will be
outstanding
Market Value: is the bond's current price
Yield to Maturity: is bond's required rate of return
Bond Valuation Procedure
The value of a bond is the present value for both of
future interest to be received and the par or
maturity value of the bond.
Mathatically:
BO = (I * ADFKb, n) + (M * DFKb, n)
Whereas: I = annual interest rate
kb = investors required rate of return
ADF = annuity discounting factor
DF = discounting factor at the required rate of return
 Example: Consider that on January 1, 2011 ABC
Company issued a 10% coupon interest rate, 10 year
bond with a $1,000 par value that pays interest annually.
The required rate of return on this bond is now 10%.
Determine the value of the bond.
 Assume another investor viewed the bond of the
company to be riskier and thus requires 12% rate of
return on this bond. Find its value.
 Further assume that an investor requires 8% return on
this bond. Find its value.
Example: A bond has Br.1,000 par values, 10 years to
maturity and a coupon rate of 10%. Bond interest is
paid semiannually. The required rate of return on this
bond is now 12%. Find the value of the bond.
Stock Valuation
Preferred Stock Valuation
The owner of preferred stock should receive a constant
income from the issuer in each period in the form of
dividends
Most preferred stocks are perpetuities. In this instance,
finding the value of preferred stock, Vp, with a level
cash flow stream continuing indefinitely
Preferred Stock Valuation
Example: Consider that ABC Company preferred stock

pays an annual dividend of Br. 3.5 par share. The share do
not have maturity date. The investor's required rate of
return is 7%. Find its value.
Common Stock Valuation
Like bonds and preferred stock, a value of common stock is
equal to the present value of all future cash flow
excepted to be received by the stockholder.
For common stock, the dividend is based on the
profitability of the firm and management's decision
to pay dividends or to retain the profits for reinvestment
purposes.
Dividend Capitalization Model
One-Period Valuation Model
Suppose an investor plans to buy a share of stock, hold it
one year, and sell it. How will this investor value the
share of stock?
The price of the stock that investor willing to pay for it is
equal to the present value of cash income the investor
will receive from purchasing the stock (the dividend (if
any) paid during the year plus the selling price at the end
of the year).
Thus,
Cont.……….
Example: Assume the expected dividend for ABC
Company is Br. 3 per share, the expected future price at
the end of year one is Br. 20 per share, and the required
rate of return is 15%. What is the value of the share to
the investor?
Cont.……….
Two-Period Valuation Model
Now, suppose the investor plans to hold a stock for two
years before selling. How is the value of the stock
determined when the investment horizon changes?
Cont.……….
Example: Let the expected dividend for ABC company
paying Br. 3 dividend in first year, be Br. 6 dividend
in second year, the expected price at the end of the second
year be Br. 25 and the required rate of return remain
15%.The value today of this common stock to the investor
would be:
Cont.……….
Multiple-Period Valuation Model
For an investor who plans to hold the stock for n periods
and then sell, the value of the stock is:
Cont.……….
Example: Assume that an investor expects Br. 4 dividend
for each of 10 years and selling price of Br. 50 at the
end of 10 years, and the required rate of return
(discount rate) is 10%; what is the value today of this
stock?
Cont.……….
Dividend Discount Model
Many investors do not contemplate selling their stock in the
near future. Since a common stock held with such
intention has an infinite life, we need to accommodate
the potentially endless series of dividends that may be
received in the future on the stock.
Cont.……….
Thus, the value of such stock is:
This model is called dividend discount model because
it shows the current price of the stock as determined
by the discounted future excepted dividends

Cont.……….
The three categories with respect to the growth rate of
dividends are: No growth, constant growth and variable
growth.
No Growth
Some companies have future dividend patterns anticipated
to be very stable This situation implies a steady or no
growth future dividend stream forever.
Thus the value of the stock is:
Cont.……….
Example: If dividend for ABC Company are expected to
be constant at Br.2.5 per share forever and if the required
rate of return on equity is 10%, what is the value of this
common stock?
Cont.……….
Constant growth
Money companies have expected dividend streams can be
growing at a constant rate for a long period of time
The value of the sock whose dividends are expected to
increase at a constant rate is given as:
Cont.……….
Example: Suppose that the market expects ABC Company
to pay a Br. 2.5 dividend next year, anticipates that
dividends will grow at 10% per year for the foreseeable
future and has a required rate of return of 15%. What is
the value of stock of the company?
Cont.……….
Variable Growth
Many firms have periods when they pay no dividends
Some firms may be going through explosive or super
growth periods.
In both cases, the dividend stream typically reverts to
constant growth or no growth at some later date.
Cont.……….
Delayed no growth or delayed constant growth
Example: Consider ABC Company, a company paying no
dividends on its common stock currently but
expected to begin paying Br. 3 a share five years from
now, at same amount in subsequent years. The
Company's required rate of return is 15%. What is the
value of common stock of the company?
Cont.……….
Supernormal Growth
Example: ABC Company is expected to have a dividend of
Br. 3, Br. 6 and Br. 10 for the first three years and it
shows a 10% growth in dividends after wards. The
Company's required rate of return is 20%. What is the
value of stock of the company?
End of Chapter Three

CH 3

Uploaded by

Copyright:

Available Formats

CH 3

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CH 3

Uploaded by

Copyright:

Available Formats

Chapter Three

Bond and Stock Valuation

A Company issued bonds when it wants to raise large sum

The Company or the borrower issued this bond to pay its

Example: Consider that ABC Company preferred stock

This model is called dividend discount model because

it shows the current price of the stock as determined

by the discounted future excepted dividends

You might also like