Lecture2016

# Lecture2016 - Lecture 16 The Value of the Common Stock...

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Lecture 16 The Value of the Common Stock Market Asset Pricing CAPM and APT provide us with a model of expected return. The question remains, what price should a stock sell for? A) Dividend Discount Model The price of a stock is equal to the infinite discounted sum of its dividends. P = (d 1 /R 1 )+ (d 2 /R 2 )+ (d 3 /R 3 )+…+ (d t /R t )+… Where R = (1+r) is the gross return appropriate for the stocks level of risk d t is the dividend paid at time t B) Price-Earnings Model The price of a stock is equal to the infinite discounted sum of its earnings. P = (E 1 /R 1 )+ (E 2 /R 2 )+ (E 3 /R 3 )+…+ (E t /R t )+… Where R = (1+r) is the gross return appropriate for the stocks level of risk E t are the earnings at time t Stock Prices : Given an expected stream of earnings (E 1 , E 2 , …E t …) and an historical estimate of a stock’s betas, we can compute the expected return of the stock from an asset pricing model and use this expected return to discount future earnings. Thus, the price of a stock depends on its risk, earnings and earnings growth

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## This note was uploaded on 04/12/2008 for the course ECON 435 taught by Professor Chabot during the Winter '08 term at University of Michigan.

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Lecture2016 - Lecture 16 The Value of the Common Stock...

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