An Example: Mortons Restaurant Group
FCF0 1 g1
FCF0 1 g1
FCF0 1 g1
VF
...
1
2
(1 r )
(1 r )
(1 r ) N
1
1
FCFN 1
N
(
1
r
)
r
g
2
VF 2001
$5,472,000 $6,238,080 $7,111,411 $8,107,009
1
2
3
4
(1.11)
(1.11)
(1.11)
(1.11)
1
$8,674,499
4
0.11 0.07
(1.11)
$4,929,730 $5,062,966 $5,199,802 $5,340,338 $142,854,029
$163,386,865
1
An Example: Mortons Restaurant Group
VF = 163,386,865
VD = $66,000,000
VP = $0
VS = $163,386,865 - $66,000,000 - $0 =
$97,386,865
Divide total share value by 4,148,002 shares
outstanding to obtain per-share value:
$97,386,865
VF
$23.40
4,148,002
Stock Valuation
Preferred stock has both debt and equity-like
features.
Common stock represents residual claims on firms
cash flows
Investment bankers play an important role in
helping firms issue new securities
The same principles apply to valuation of both
preferred and common stock
Valuation Fundamentals:
Preferred Stock
Preferred stock is an equity security that is expected
to pay a fixed annual dividend indefinitely.
PS 0 =
Dp
PS0 = Preferred stocks market
price
rp
Dp = next periods dividend
payment
rp = discount rate
An example: Investors require an 11% return on a preferred
stock that pays a $2.30 annual dividend. What is the price?
PS 0 =
4
Dp
rp
$2.3
= $20.90 / share
0.11
Investment Banks Role in Equity
Offerings
Trading
Investment banking
lines of business
Asset management
Corporate finance
Investment banks provide advice with structuring
seasoned
seasoned and
unseasoned issues.
unseasoned
Seasoned
offering
Unseasoned
offering
Equity issues by firms that already
have common stock outstanding.
Initial public offering (IPO): issue of
securities that are not traded yet.
Investment Banks Role in Equity
Offerings
Firms can choose an investment bank through
Direct negotiated offer
Competitive bidding
Public security issues can be
Best
efforts
Firm
6
commitment
The bank promises its best efforts to sell
the firms securities. No guarantees
though about the success of the offering.
Underwritten offerings, bank
guarantees certain proceeds.
Vast majority of US security offerings
are underwritten.
Investment Bank Services and Costs
Services provided by investment banks prior to
security offering
Primary pre-issue role: provide advice and help plan offer
Firm seeking capital selects lead underwriter(s).
Top firm is the lead manager, others are co-managers.
Offering syndicate organized early in process
Prior to offering, lead investment bank negotiates
underwriting agreement
Sets offer price and spread; details lock-up agreement
Bulge bracket underwriters spread usually 7.0% for IPOs
Initial offer price set as range; final price set day before
offer
Services Provided during and after a
Security Offering
Lead underwriter sets each syndicate members
participation.
How many shares each member must sell and
compensation for each sale
Almost all IPOs and SEOs have a green shoe option:
over-allotment option to cover excess demand.
Lead underwriter responsible for price stabilization
after offering.
After offering, lead underwriter serves as principal
market maker.
Secondary Market
On the secondary market, investors deal among
themselves.
Securities exchanges
Centralized locations in which listed securities are bought
and sold
NYSE: the largest exchange in the world, with almost 360
billion shares listed. Other exchanges: AMEX, regional
exchanges
The Over-the-counter market (OTC)
OTC has no central, physical location; linked by a mass
telecommunication network.
A part of the OTC market is made up of stocks traded on
NASDAQ.