Slide+8+-+Stock+Valuation

# Slide+8+-+Stock+Valuation - Stock Valuation by Diep Duong...

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Stock Valuation by Diep Duong

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Outline Common Stock Valuation using Present Value Model Some Features of Common and Preferred Stocks The Stock Markets
Value Stock as An Asset Now you are an expert in Present Value (PV) model. You also have a big example of Bond Use PV to value stock, an asset giving future incomes and also is traded in the market. What do you need to value stock ? - Structure of Future Cash Flows - Number of Period - Discount rate + Market required rate if traded in the market + Or your subjective point of view

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Cash Flows for Stockholders Have a quick review on stock definition Stock generates income and capital gains If you buy stock today, you can receive Dividends as income (Income Gain) Future price of stock once you sell it (Capital Gain) So, you need two things: - There is no default - There is a market for the stock - What if you miss one of the two ? What is different between stock and bond in term of cash-generating ?
One-Period Example 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? Compute the PV of the expected cash flows Price = (14 + 2) / (1.2) = \$13.33 Or FV = 16; I/Y = 20; N = 1; CPT PV = -13.33

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Two-Period Example Now, what if you decide to hold the stock for two years? In addition to the dividend in one year, you expect a dividend of \$2.10 in two years and a stock price of \$14.70 at the end of year 2. Now how much would you be willing to pay? PV = 2 / (1.2) + (2.10 + 14.70) / (1.2) 2 = 13.33
Three-Period Example Finally, what if you decide to hold the stock for three years? In addition to the dividends at the end of years 1 and 2, you expect to receive a dividend of \$2.205 at the end of year 3 and the stock price is expected to be \$15.435. Now how much would you be willing to pay?

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