Valuation methods and cost of capital Flashcards
constant growth dividend discount model (dividend growth model)
a method of arriving at the value of the stock by using expected dividends per share and discounting them back to present value
= last dividend paid x (1 + growth rate) / (discount rate - dividend growth rate)
only use when dividends are growing at a constant rate
Steps in the two-stage dividend discount model
- Calculate and sum the present value of the dividends in the period of high growth
- Calculate the present value of the stock based on the period of steady growth, discounting the value back to year 1
- Sum the totals calculated in Step 1 and 2.
preferred stock valuation
dividend per share / cost of capital
component cost of debt
the after-tax interest rate on the debt
effective rate x (1.0 - marginal tax rate)
component cost of preferred stock
cash dividend on preferred stock / market price of preferred stock
component cost of common stock
cash dividend on common stock / market price of common stock
weighted-average cost of capital
a single composite rate of return on its combined components of capital
weights are based on the components’ respective market values
WACC formula
weight x component cost summed for all components
What does the optimal capital structure model hold?
shareholder wealth maximization results from minimizing the weighted-average cost of capital
cost of new debt
annual interest / net issue proceeds
cost of new preferred stock
next dividend / net issue proceeds
cost of new common stock
(next dividend / net issue proceeds) + dividend growth rate