Lecture 7 - Lecture7

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Lecture 7 This chapter presents the techniques that can be used to value equity instruments.  Basic valuation  Suppose that you are interested in buying Pepsi Co. stock today.  Through your research, you feel for sure  that Pepsi Co.’s share will be $45 in one year from today when you plan to sell the share.  Furthermore,  you think that $5/share of dividends will be paid at the end of one year.  How much would you be willing  to pay for this stock today if you require 20% return on this investment? 67 . 41 $ ) 20 . 1 ( 45 $ 5 $ ˆ 0 = + + = P Hence, with the forecast you made, $41.67 would be the current price you would assign.  This price is  intrinsic value , a particular price an investor assigns to a stock based on the fact.   Then, the investor compares his/her intrinsic value to the actual price of the stock in the market.  If the  current stock price in the market is less than or equal to 441.67, you would purchase this stock.  However,  if the current price exceeds the $41.67, you would not pursue this investment. In a more general mathematical term, we can show this as: ) 1 ( ) ( ˆ 1 1 0 s k P D P + + = What is the investment horizon is more than one period?  Then, we can find the intrinsic value with the  following equation: = + + + = n t n s n t s t k P k D P 1 0 ) 1 ( ) 1 ( ˆ So, the current price (intrinsic value) of a stock is the present value of future expected dividend streams  plus present value of the stock price at future time t.  However, the present value of the stock price at future  time t is commonly dropped as we assume almost infinite number of investment horizon.  As the n goes 
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This note was uploaded on 09/06/2010 for the course ACCT 3220 taught by Professor Las during the Spring '10 term at Fordham.

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Lecture 7 - Lecture7

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