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chapter7a

# chapter7a - Chapter 7 Valuing Stocks Issues Computing stock...

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Chapter 7 Valuing Stocks Issues: Computing stock prices using the dividend growth model Features of common and preferred stocks

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2 Cash Flows to Stockholders If you buy a share of stock, you can receive cash in two ways The company pays dividends You sell your shares As with bonds, the price of the stock is the present value of these expected cash flows
3 Examples Suppose you are thinking of purchasing the stock of Moore Oil, Inc. You expect it to pay a \$2 dividend in one year, and you believe that you can sell the stock for \$14 at that time. If you require a return of 20% on investments of this risk, what is the maximum you would be willing to pay? Now, what if you decide to hold the stock for two years? In addition to the \$2 dividend in one year, you expect a dividend of \$2.10 and a stock price of \$14.70 both at the end of year 2. Now how much would you be willing to pay?

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4 Example extension What if you decide to hold the stock for three periods? In addition to the dividends at the end of years 1 and 2, you expect to receive a dividend of \$2.205 and a stock price of \$15.435 both at the end of year 3. Now how much would you be willing to pay? What if you hold for four years? For five years? For more years? You could continue to push back when you would sell the stock
Developing The Model Holding for one period: Holding for two periods: Holding for H periods: Holding forever: You would find that the price of the stock is really just the present value of all expected future dividends So, how can we estimate all future dividend payments? r P D P + = + 1 0 1 1 2 2 2 1 ) 1 ( 1 0 r P D r D P + + + = + H H H r P D r D r D P ) 1 ( .. .......... ) 1

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chapter7a - Chapter 7 Valuing Stocks Issues Computing stock...

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