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Sess06 new - Lecture 6: Valuing Stocks Reading: RWJ Chapter...

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Fin3715 – Fall 07 – Kayhan 1 Lecture 6: Valuing Stocks Reading: RWJ Chapter 8 Outline: Types of Markets Valuing Stocks Interpreting Discount Rates Assessing Growth Present Value of Growth Opportunities
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Fin3715 – Fall 07 – Kayhan 2 Common Stock – Ownership shares (equity) in a publicly held corporation. (Residual) cash flow rights and control rights. Infinite life (no maturity) Primary Market – market in which corporations and governments sell securities to raise capital. Public versus Private offerings Secondary Market – market in which already issued securities are traded by investors.
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Fin3715 – Fall 07 – Kayhan 3 Auction Markets : Physical location (NYSE, LSE, regional exchanges) Matches buyers and sellers The stock of most large firms trade in auction markets Dealer (over the counter) Markets : No centralized location – connected by computer or telephone Dealers buy and sell securities Examples: NASDAQ, most debt markets, currency markets, etc.
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Fin3715 – Fall 07 – Kayhan 4 Valuing Common Stocks Dividend Discount Model The value of a stock is the present value of its future cash flows. A stock’s future cash flows are its dividends. + + + + + + + + = ) 1 ( ) 1 ( ) 1 ( ) 1 ( 3 3 2 2 1 1 0 r D r D r D r D P
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Fin3715 – Fall 07 – Kayhan 5 Valuing Stocks: Examples Simplest case – constant dividends: Value the stock as a perpetuity Gordon Growth Model : Dividends grow at a constant rate g Value the stock as a growing perpetuity. r D P 1 0 = g - r D P 1 0 =
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Fin3715 – Fall 07 – Kayhan 6 Example 1: Constant Dividends In 1946, Colgate-Palmolive issued a preferred stock with $100 par value and 4.25% annual dividends to be paid on Dec. 31. Assume the preferred stock has no default risk and can be discounted at a rate r = 5%. What is the price of the preferred stock on Jan. 1?
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Fin3715 – Fall 07 – Kayhan 7 Example 1: Constant Dividends (Sol’n) On Jan. 1, next dividend is paid in a year, D = 100 (4.25%) = 4.25 P = D/r = 4.25/.05 = 85
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Fin3715 – Fall 07 – Kayhan 8 Example 2: Constant Growth Assume GM has just paid a dividend of $2.00, and you expect its dividends to grow at 3% every year forever. If you require a 9% return from GM, what is the stock worth today?
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Fin3715 – Fall 07 – Kayhan 9 Example 2: Constant Growth (Sol’n) 34.33 .03 - .09 2.06 g - r D P 06 . 2 ) 1 ( D D 3% g 9%, r 2, D 1 0 0 1 0 = = = = + × = = = = g
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This note was uploaded on 05/06/2008 for the course FIN 3715 taught by Professor Stephens during the Spring '08 term at LSU.

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Sess06 new - Lecture 6: Valuing Stocks Reading: RWJ Chapter...

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