09Class15

09Class15 - The Substitution Solving for Dt we get: Dt =...

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1 Solving for D t we get: D t = CI t + BV t-1 -BV t Substituting for D t we get V = (CI 1 + BV 0 – BV 1 )/(1+r) + (CI 2 + BV 1 – BV 2 )/(1+r) 2 + …. The Substitution
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2 BV 0 /(1+r) = BV 0 – rBV 0 /(1+r) And for all t > 0, -BV t /(1+r) t +BV t /(1+r) t+1 = -rBV t /(1+r) t+1 Two Further Substitutions
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3 V = BV 0 + (CI 1 – rBV 0 )/(1+r) + (CI 2 – rBV 1 )/(1+r) 2 + … The terms CI t – rBV t-1 have an interesting economic interpretation. The Residual Income Valuation Model
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4 The term CI t – rBV t-1 has been called: residual income, economic value added, economic profit and abnormal profit. Thus the Residual Income Valuation model says that the value of common stock equals its book value plus the present value of future residual income. Business Week article Earnings Per Share? Phooey!: A successful money manager says “ EPS is just an accounting number, when the real key to stock price is economic profit.” Interpretation of CI - rBV
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5 In the fall of 2007 an article in the Financial Times said the Shanghai index was overpriced. It based this on two facts in combination. 1. The average market to book ratio for stocks in the index is high --- nearly 5. 2.
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This note was uploaded on 04/21/2009 for the course MGMT 126 taught by Professor Miller during the Winter '09 term at UCLA.

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09Class15 - The Substitution Solving for Dt we get: Dt =...

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