5-3b[1].- Stock Valuation

5-3b[1].- Stock Valuation - Stock Valuation Ramesh Rao 1...

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Ramesh Rao 1 Stock Valuation
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Ramesh Rao 2 Chapter Organization A. Preliminaries B. Basics of Stock Valuation B1. Valuation in a Single-Period world B2. Multi-period with constant dividends B3. Growth B4. Estimating Growth Rates B5. A Differential Growth Example A. Understanding Growth and Growth Options (PVGO): Leland Cement Company B. Other Price Ratio Analysis E. Stock Market Reporting
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Ramesh Rao 3 A. Preliminaries Book value, Liquidation value, Market value What is the market value of an asset? Then, what is the market value of a stock? What are the difficulties? How do we deal with them?
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Ramesh Rao 4 B1. Valuation in a Single- Period world r P Div P + + = 1 1 1 0 Div 1 +P 1 P o 0 0 1 0 1 P P P P Div r - + = Key Ideas? (Income v. growth) High dividend paying stocks are called “income” stocks High capital gain stocks are called “growth” stocks What do you not like about this?
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Ramesh Rao 5 B2. Multi-period with constant dividends Div Div Div Div = = = = 2 1 r Div P = 0 Value of a share of stock with constant dividends is calculated as a level perpetuity. Thus, if a your family business pays $3/yr in dividends, its stock will sell for today for $20 if the discount rate is 15% What do you not like about this?
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Ramesh Rao 6 B3. Growth We often assume that a firm’s dividends grow at a constant rate. Regular growth rates are often stated as managerial goals. They are a good approximation in many cases. This assumption allows stock to be valued as a growing perpetuity.
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Ramesh Rao 7 Constant Dividend Growth (Gordon Model) g = Growth rate of cash flows--dividends Assume that g is constant over stated horizon ( 29 ( 29 ( 29 ( 29 ( 29 + + + + + + + + + = r g Div r g Div r g Div P 1 1 1 1 1 1 0 2 2 0 0 0 ( 29 t t g Div Div + = 1 0 ( 29 g r Div g r g Div P - = - + = 1 0 0 1 How did this happen !!? Critical Assumptions?
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Ramesh Rao 8 Constant Dividend Growth Example You have increased productivity in your company and dividends are expected to increase by 5%/year indefinitely, without changing the discount rate (15%). How much is the stock worth now if the current dividend is $3?
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