THE COPPERBELT

UNIVERSITY
SCHOOL OF BUSINESS

BF 224:Corporate
Finance

Session 4: Stock Valuation

Dr Young Kafwembe 2024/25
Share Vs Stock

Share Stock
• Share is a unit issued by a • Stocks in the reference of stock
company at the time of market are the total number of
shares a person has in one
raising fund from the company or in many
market. companies.
• Two types of corporate stocks
• It is the smallest unit of
ownership that may be
bought or sold on or off an
exchange.
Two types of stock
1. Common stock – Represents ownership in a
company

2. Preferred stock – Has characteristics of

debt and equity
 Preferred
Preferred Stock
Stock Valuation
Valuation

Preferred Stock is a type of

stock that promises a (usually)
fixed dividend, but at the
discretion of the board of
directors.
Preferred Stock has preference over
common stock in the payment of dividends
and claims on assets.
4
 Preferred
Preferred Stock
Stock Valuation
Valuation
V = DivP / kP
Or

PV = C on the preferred stock and

Where : DivP is the dividend
kP is the required rate
r of return.
C is payment, r is interest rate per period

This is a perpetuity!
5
 Preferred
Preferred Stock
Stock Example
Example
Stock PS has an 8% dividend, $100 issue
outstanding. The appropriate discount rate
is 10%. What is the value of the preferred
stock?
DivP = $100 ( 8% ) = $8.00. kP =
10%.

V = DivP / kP = $8.00 / 10% =

$80
6
 Common
Common Stock
Stock Valuation
Valuation
Common stock represents a residual
ownership position in the corporation.

• Pro rata share of future

earnings after all other
obligations of the firm (if
any remain).
• Dividends may be paid out of
the pro rata (proportion) share
of earnings.
7
Common Stock Valuation
• Common stocks represent an interest in the
ownership of a company. Shares entitle shareholders to
dividends but do not guarantee payment of dividend all
the time. Shares can also be sold at some future date at
a higher price. This allows the shareholder to earn
Capital Gains. It is also possible to make capital losses if
share prices depreciate. The main cash flow streams
from stocks are dividends and capital gains resulting
from selling the shares at a higher price.
 Common
Common Stock
Stock Valuation
Valuation

What cash flows will a shareholder

receive when owning shares of
common stock?

(1) Future dividends

(2) Future sale of the
common stock shares
9
 Dividend
Dividend Valuation
Valuation Model
Model
Basic dividend valuation model accounts for the
PV of all future dividends

The value of a stock depends on whether the

dividend is static (Zero growth); growing from
year to year at constant rate or growing at a
non constant rate.
Hence the following models have been developed.

10
 Dividend
Dividend Growth
Growth
Pattern
Pattern Assumptions
Assumptions

The dividend valuation model requires the

forecast of all future dividends. The following
dividend growth rate assumptions simplify the
valuation process.
Constant Growth
No Growth (Zero growth);
Growth Phases (growing at a non constant
rate).

11
 Constant
Constant Growth
Growth Model
Model
(Gordon’s
(Gordon’s model)
model)

The constant growth model assumes that

dividends will grow forever at the rate g.
V = D0(1+g)
Ks-g

Or = D1/ks-g
It is applicable to stock valuation when the dividend grows at a constant rate of growth g.
Where
V is the Price or value of the stock today
D0 is the dividend just paid and D1 is the dividend paid at the end of year one.
g is the constant growth rate
KS (Ke) is the discount rate.(Investor’s required return )Note; is Ks>g

12
 Constant Growth
Model Example
Stock CG has an expected dividend growth
rate of 8%. Each share of stock just received
an annual $3.24 dividend. The appropriate
discount rate is 15%. What is the value of
the common stock?
D1 = $3.24 ( 1 + 0.08 ) = $3.50

VCG = D1 / ( ke - g ) = $3.50 / (0.15 - 0.08 )

= $50

13
 Zero Growth Model
The zero growth model assumes that dividends
will grow forever at the rate g = 0.

D1 D1: Dividend paid at time 1.

V k
ke: Investor’s required return.
=
e

14
 Zero Growth
Model Example
Stock ZG has an expected growth rate of
0%. Each share of stock just received an
annual $3.24 dividend per share. The
appropriate discount rate is 15%. What is
the value of the common stock?

D1 = $3.24 ( 1 + 0 ) = $3.24

VZG = D1 / ( ke - 0 ) = $3.24 / (0.15 - 0 )

= $21.60
15
 Non – Constant or
Growth Phases Model
This is a model that is applied when
growth is not constant

The growth phases model assumes

that dividends for each share will
grow at two or more different growth
rates.

16
• Growth Phases Model
Example

• A company’s required rate of return is 16%

and the dividend growth at a rate of 30% g1
for 3 years and then it dropped to a
constant growth rate of 10% g2 thereafter.
The most recently paid dividend was D0=
K1.82. Find the value of the stock?
 Growth Phases
Model
Example
Ks= 16%,
N = years for super normal growth 3 years
g1= growth rate during supernormal growth 30%
g2= constant growth after supernormal growth
10%
D0= last dividend that the company just
paid=K1.82
Note that the second phase of the growth phases
model assumes that dividends will grow at a
constant rate g2. We can rewrite the formula as:

18
Where dividends grow a varying growth rates the
following steps are required to solve such a question.

• Step 1 Find the PV of the dividend during the period of

non constant growth by first finding respective
dividends for each year and then discounting those cash
flows.
• Step 2 Find the price of the stock at the end of the non
constant growth period, at which point it has become a
constant growth stock and then discount this price back
to the present.
• Steps 3 finally add the two values found in step 2 and 3
to determine the value of the stock today.
Steps 1 find the PV of dividends from year 1- 3

• D1= 1.82(1.30)1 = 2.366 >D1 = DO(1+G) t

D2= 1.82(1.30)2 = 3.076
D3= 1.82(1.30)3 = 3.999
Present Values of the dividends are found by
discounting each dividend to the present.
2.366 (0.8621) = K2.040 D1 > D1(PVIF,16,1)
3.076(0.7422) = K2.286 D2
3.999(0.6407) = K2.562 D3
Total K6.888
 Growth Phases
Model Example

0 1 2 3 4 5 6

D1 D2 D3 D4 D5 D6

Growth of g1 = 30% for 3 years

Growth of g2 = 10% to infinity!

The Stock has two phases of growth. The first, 30%,

starts at time t=0 for 3 years and is followed by 10%
thereafter starting at time t=3. We should view the
time line as two separate time lines in the valuation.

21
Step 2 Find the present values of the dividends expected from year 4
onwards.

P3= D4/ks-g
= 3.999(1.10)1
0.06
= K73.32
This is the price of the stock at the end of year 3,so we to
discount back to the present 3 years back.
PV of P3
K73.32(PVIF16%,3years)
= 73.32(0.6407)
=K46.98
Step 3 Find the price of the stock by adding the two components found in step one and step two.

P0= K6.89+K46.98
= K53.87
This represents the value of the stock today in the
market.
 Growth Phases
Model Example
Stock GP has an expected growth rate of
16% for the first 3 years and 8% thereafter.
Each share of stock just received an annual
$3.24 dividend per share. The appropriate
discount rate is 15%. What is the value of
the common stock under this scenario?

24
 Growth Phases
Model Example

0 1 2 3 4 5 6 

D1 D2 D3 D4 D5 D6

Growth of 16% for 3 years Growth of 8% to infinity!

Stock GP has two phases of growth. The first, 16%,

starts at time t=0 for 3 years and is followed by 8%
thereafter starting at time t=3. We should view the
time line as two separate time lines in the valuation.

25
 Growth Phases
Model Example

0 1 2 3 Growth Phase
#1 plus the infinitely long
Phase #2
D1 D2 D3
0 1 2 3 4 5 6 

D4 D5 D6
Note that we can value Phase #2 using the
Constant Growth Model
26
 Growth Phases
Model Example

D4 We can use this model because

(P )
3 V3 = k-g dividends grow at a constant 8%
rate beginning at the end of Year 3.

0 1 2 3 4 5 6 

D4 D5 D6
Note that we can now replace all dividends from
year 4 to infinity with the value at time t=3, V3!
Simpler!!
27
 Growth Phases
Model Example

0 1 2 3 New Time
Line

D1 D2 D3
0 1 2 3
Where V3 = D4
k-g
V3
Now we only need to find the first four
dividends to calculate the necessary cash
flows.
28
 Growth Phases
Model Example
Determine the annual dividends.
D0 = $3.24 (this has been paid already)
D1 = D0(1 + g1)1 = $3.24(1.16)1 =$3.76
D2 = D0(1 + g1)2 = $3.24(1.16)2 =$4.36
D3 = D0(1 + g1)3 = $3.24(1.16)3 =$5.06
D4 = D3(1 + g2)1 = $5.06(1.08)1 =$5.46

29
 Growth Phases
Model Example

0 1 2 3 Actual
Values

3.76 4.36 5.06

0 1 2 3
5.46
Where $78 0.15–0.08
=
78
Now we need to find the present
value of the cash flows.

30
 Growth
Growth Phases
Phases Model
Model
Example
Example
We determine the PV of cash flows.
PV(D1) = D1(PVIF15%, 1) = $3.76 (0.870) = $3.27

PV(D2) = D2(PVIF15%, 2) = $4.36 (0.756) = $3.30

PV(D3) = D3(PVIF15%, 3) = $5.06 (0.658) = $3.33

9.90

P3 = $5.46 / (0.15 - 0.08) = $78 [CG

Model]

PV(P3) = P3(PVIF15%, 3) = $78 (0.658) = 31

 Growth Phases
Model Example
Finally, we calculate the intrinsic value by
summing all of cash flow present values.

V= $3.27 + $3.30 + $3.33 + $51.32

V = $61.22

32
 Determining the Yield
on Preferred Stock

Determine the yield for preferred stock with

an infinite life.
P0 = DivP / kP

Solving for kP such that

kP = DivP / P0

33
 Preferred Stock Yield
Example

Assume that the annual dividend on

each share of preferred stock is $10.
Each share of preferred stock is
currently trading at $100. What is the
yield on preferred stock?
kP = $10 / $100.
kP = 10%.
34
 Determining the Yield
on Common Stock
To Assume this, the constant growth model
is appropriate. Determine the yield on the
common stock.
P0 = D1 / ( ke – g )

Solving for ke such that

ke = ( D1 / P0 ) + g

35
Yields on constant growth stock are
determined as follows:
Expected Yield (ke) = Dividend Yield + Capital Gains Yield

Expected Yield (ke) = (D1/Po) + g

g= Capital Gains Yield

Example
A stock originally sold for K20 per share and now sells for K25.The
dividend last paid was K5.Find the Dividend yield and capital gains
yield and total yield or return.

Expected Yield (ke) = Dividend Yield + Capital

Gains Yield
Expected Yield (ke) = (D1/Po) + g
Dividend yield = (K5/K20) = 25%
Capital Gain = K25-K20 = K5
Capital Gains yield = K5/K20 =25%
Total Yield (Ke)= 25%+25% =50%
NOTE. Suppose the stock had a growth rate g of 5% this
represent the capital gains yield for such a stock.
 Common Stock
Yield Example
Assume that the expected dividend (D1)
on each share of common stock is $3.
Each share of common stock is
currently trading at $30 and has an
expected growth rate of 5%. What is the
yield on common stock?
ke = ( $3 / $30 ) + 5%
ke = 10% + 5% = 15%
38
Congratulations!
You are now all financial
Graduates!
End of lecture 3!
END

• QUESTIONS