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BCOR 2200 Chapter 7

# BCOR 2200 Chapter 7 - Chapter 7 Equity Markets Stock...

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1 Chapter 7 Equity Markets & Stock Valuation

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2 Outline: Common Stock Valuation Features of Common and Preferred Stocks The Stock Markets Concepts and Skills: Stock prices depend on 1. Future dividends 2. Dividend growth Compute stock prices using the dividend growth model Understand how corporate directors are elected Understand how stock markets work Understand how stock prices are quoted
3 7.1 Common Stock Valuation Share of Ownership Entitles you to: 1. Share of Profits 2. Share of Assets If the company is liquidated After creditors (including bond holders) get their money 3. Share of vote for Board of Directors A share is worth the PV all the money that the owner gets: 1. Dividends (profits paid to shareholders) 2. Cash from the sale of the stock

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4 Example: A stock is held for 1 year: It will pay a \$2 dividend in one year It can be sold for \$14 in one year The required return is 20% on investments with this risk Calculate the most you are willing to pay: P 0 = Price at time 0 D 1 = Dividend at time 1 P 1 = Price at time 1 ( 29 ( 29 33 . 13 \$ 0 2 . 1 14 \$ 2 \$ R 1 P D P 1 1 1 1 0 = + = + + =
5 Example: Same stock is held for 2 years: Div at time 2 = \$2.10 D 1 = \$2.00 and D 2 = \$2.10 Price at time 2 = P 2 = \$14.70 Still require a 20% return Cash flow diagram: ( 29 ( 29 ( 29 ( 29 33 . 13 \$ 0 2 . 1 70 . 14 \$ 10 . 2 \$ 0 2 . 1 2 \$ R 1 P D R 1 D P 2 1 2 2 2 1 1 0 = + + = + + + + = P 0 \$14.70 0 1 2 \$2.00 \$2.10

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Clicker Question: 6

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8 General Formula For a Stock’s Price: • The price at any time (including now, P 0 ) is the present value of all future cash flows For a stock the CFs are called dividends If we sell the stock, then we get the Price at the time it is sold. How do you calculate the price at the time of sale? ( 29 ( 29 ( 29 ( 29 + + + + + + + + = 4 4 3 3 2 2 1 0 R 1 D R 1 D R 1 D R 1 D P
9 Derivation of General Formula (Part 1): P 0 is a function of D 1 and P 1 But P 1 is a function of D 2 and P 2 . So Sub for P 1 in P 0 equation: ( 29 R 1 P D P 2 2 1 + + = ( 29 R 1 P D P 1 1 0 + + = ( 29 ( 29 ( 29 ( 29 2 2 2 1 1 0 2 2 1 0 R 1 P D R 1 D P R 1 R 1 P D D P + + + + = + + + + =

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10 Derivation of General Formula (Part 2): So now P 0 is a function of D 1 , D 2 and P 2 But P 2 can be written as a function of D 3 and P 3 So Sub for P 2 in P 0 equation and get P 0 as a function D 1 , D 2 , D 3 and P 3 : But P 3 can be written as a function of D 4 and P 4 and so on… ( 29 R 1 P D P 3 3 2 + + = ( 29 ( 29 2 2 2 1 1 0 R 1 P D R 1 D P + + + + = ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 3 3 3 2 2 1 0 2 3 3 2 1 0 R 1 P D R 1 D R 1 D P R 1 R 1 P D D R 1 D P + + + + + + = + + + + + + = ( 29 ( 29 ( 29 ( 29 + + + + + + + + = 4 4 3 3 2 2 1 0 R 1 D R 1 D R 1 D R 1 D P
11 General Formula Discussion The price at any time (including now) is: The present value of all future cash flows A stock’s CFs are called dividends Its as if we just keep pushing back the sale time to

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BCOR 2200 Chapter 7 - Chapter 7 Equity Markets Stock...

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