Chapter_08_Presentation

# Chapter_08_Presentation - 8 Stock Valuation How big...

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8 Stock Valuation

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8-2 How big? How big? According to Thomson Financial in April 2007, the market cap of Europe’s 24 stock markets totaled \$15.7 trillion. This was just higher than the U.S. market at \$15.6 trillion. The 30 stocks of the DJIA account for \$3.6T (as of 9/29/2008). The largest stock is Exxon Mobil at \$409B in market cap, followed by GE (\$247B), Microsoft (\$245B), Wal-Mart (\$237B), Proctor and Gamble (\$208B), Johnson and Johnson (\$194B), AT&T (\$172B), Chevron (\$171B), J.P. Morgan (\$157B) and IBM (\$157B). GM is the smallest (\$5.5B). Kraft recently replaced AIG. Chevron and Bank of America were also recent additions, replacing Altria and Honeywell. United Technologies (\$64B) is also on the list. What do they do?
8-3 Cash Flows for Stockholders Cash Flows for Stockholders If you buy a share of stock, you can receive cash in two ways The company pays dividends You sell your shares, either to another investor in the market or back to the company As with bonds, the price of the stock is the present value of these expected cash flows

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8-4 One Period Example One Period Example Suppose you are thinking of purchasing the stock of Moore Oil, Inc. and you expect it to pay a \$2 dividend in one year and you believe that you can sell the stock for \$14 at that time. If you require a return of 20% on investments of this risk, what is the maximum you would be willing to pay? Compute the PV of the expected cash flows Price = (14 + 2) / (1.2) = \$13.33 Or FV = 16; I/Y = 20; N = 1; CPT PV = -13.33
8-5 Two Period Example Two Period Example Now what if you decide to hold the stock for two years? In addition to the dividend in one year, you expect a dividend of \$2.10 in two years and a stock price of \$14.70 at the end of year 2. Now how much would you be willing to pay? PV = 2 / (1.2) + (2.10 + 14.70) / (1.2) 2 = 13.33

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8-6 Developing The Model Developing The Model You could continue to push back when you would sell the stock You would find that the price of the stock is really just the present value of all expected future dividends So, how can we estimate all future dividend payments?
Estimating Dividends: Special Cases Estimating Dividends: Special Cases Constant dividend The firm will pay a constant dividend forever This is like preferred stock The price is computed using the perpetuity formula Constant dividend growth

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## This note was uploaded on 02/20/2009 for the course H ADM 225 taught by Professor Jwellman during the Fall '07 term at Cornell.

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Chapter_08_Presentation - 8 Stock Valuation How big...

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