MGMT_130_Lecture_7

# MGMT_130_Lecture_7 - MGMT 130 Lecture 7 Stock Valuation...

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MGMT 130 Lecture 7 Stock Valuation

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Value of Stocks Stocks are residual claims on future cash flows. As with bonds, or any other financial instrument, their price is determined by the present value of those future cash flows. However, those cash flows are not as easy to determine as it is for bonds. Nor is the appropriate discount rate. Today we investigate a simple model to help us estimate those future cash flows and discount rates.
Price and Dividends A stockholder is entitled to two types of cash flows. First, a stockholder receives any dividends paid by the company. Second, a stockholder receives the market value of the stock upon sale. So, a stock is worth the present value of the dividends paid during the holding period plus the present value of the eventual sale price. And the eventual sale price is worth… the present value of dividends paid plus the next sale price…

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Discounted Future Dividends So, a stock is worth the discounted present value of all future dividends. r P r Div P + + + = 1 1 1 1 0 r P r Div P + + + = 1 1 2 2 1 ( 29 ( 29 ( 29 = + = + + + + + = 1 2 2 2 2 1 0 1 1 1 1 t t t r Div r P r Div r Div P
Movement in Stock Prices What makes a stock price go up? Present value of future dividends must have increased. Either the cash amount of the dividends has become larger, or the discount rate used to deflate those dividends has decreased. Examples? What about increasing earnings vs. dividends? Stock prices move daily, sometimes dramatically. Does the present value of future dividends change that quickly?

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Valuing Future Dividends If dividends are constant, then our stock valuation conforms to the perpetuity formula. The value of a stock is then worth: Div/r If dividends grow at a constant rate: then the value is just g r Div P - = 0
Examples Let’s use a 10% discount rate and a company that pays a \$1 annual dividend. What if the dividends grow at 2% per year?

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## This note was uploaded on 04/25/2010 for the course MGMT 130A taught by Professor Stuff during the Winter '10 term at UCLA.

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MGMT_130_Lecture_7 - MGMT 130 Lecture 7 Stock Valuation...

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