On this web page we look at the definition of Common Stocks and formula for valuation of such stock along with an example illustrating such valuation.
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How you define common stocks
is the most prevalent of capital stocks. When a corporation has only one kind of capital stock, it will be common stock. When the stock is issued, the owners receive certain rights from the corporation. These rights include
- The right to vote at stockholders' meetings
- The right to share in profits by receiving dividends
- The right to dispose of or sell their stock
- The right to maintain their proportionate ownership interest in the company. This is called preemptive right
- The right, when a company is liquidated to share in assets after creditors and others with prior claims are paid off
How do you do Valuation of common stocks
Dividend Discount Models are designed to compute the intrinsic value of a share of common stock under specific assumptions as to the expected growth trends of future dividends and the appropriate discount rate to employ. Morgan Stanley, Merrill Lynch and a number of other investment banks make such calculations based on their own models and estimates. One such model is constant growth rate when dividends are expected to grow at a constant rate. The following equation and its variation is used to value such stocks
where D0 is the present dividend per share. Thus the dividend expected at the end of period n is equal to the most recent dividend times the compound growth factor (1+g)n.
We must assume that ke is greater than g because a dividend growth rate that is always greater than the capitalization rate would imply an infinite stock value, we could rewrite the above equation as
User submitted IRR Questions/Problems
Asked:
Julio purchased a stock one year agofor $27. The stock is now worth $32, and the total return to Julio for owning stock was 37 percent. What is the dollar amount of dividends that he received for owning stock during the year?
- a) $4
- b) $5
- c) $6
- d) $7
Francis purchased a stock one year ago for $20 and it is now worth $24. The stock paid a dividend of $3 during the year. What was the stock's rate of return from capital appreciation during the year
- a) 17%
- b) 20%
- c) 29%
- d) 35%
Gwen purchased a stock one year ago for $25. and it is now worth $31. The stock paid a dividend of 1.50 during the year. What was the stock's rate of return income during the year
- a) 6%
- b) 15%
- c) 24%
- d) 26%
Replied:
Hi Dawn
the answers are
- Q1 - (b) $5
- Q2 - (c) 29%
- Q3 - (c) 24%
Download MS Excel Worksheet for solutions to common stocks required rate of return calculations
Asked:
Ahmet purchased stock for $45.00 one year ago. The stock is now worth $65.00. During that year, the stock paid a dividend of $2.50. What is the total return to Ahmet for owning the stock?
- a) 5%
- b) 44%
- c) 35%
- d) 50%
Replied:
Hi Dawn
I get a rate of return of 48.28%, I guess had I rounded off the growth rate to 0 decimal places it would come out to 50%
See the attached MS Excel WorkSheet for the equation and calculation of required rate of retrun on common stock
Download MS Excel Worksheet for solutions to calculation of required rate of retrun on common stock
Asked:
What will be the firms equity multiplier given a debt ratio of 0.45?
- a) 1.82
- b) 1.28
- c) 2.22
- d) none of the above
Replied:
Hi Dawn
The Equity Multiplier is 1.82
See the attached MS Excel WorkSheet for the equation and calculation of Equity Multiplier