Chatper 7 Notes

# Chatper 7 Notes - Chapter 7 Stock Valuation...

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Chapter 7: Stock Valuation (ll2) Assignments: #7-2,7-4, 7-6,7-7,7-16,7-21on page 297 -299 due on Thursday (10/16/2008) D\15'--\!' 1.Stockvaluation_Dividenddiscountmodel(DDM)\ !), OL tl! i'r':" Recall the global valuation formula: €o'., i AssetValue: C4 r* CF, ^*...* CFr=, (1+r)' (l+r)2 (l +r)* You may have noticed that since the above equation is the sum of "discounted future values," the "Asset Value" or "Valuation" is nothing but "PV" or finding PV. You want to utilize the above formula for the valuation of stock as you did for the valuation of bond! What is CF and r? CF is: dividend payment (D). (Note that common stock does not have maturity whereas some of preferred stock can be recalled based on call provision.) f is: r", the rate ofreturn (or rate ofinterest) on the stock.

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t \. t)i i,r r p\ <-n^' a\ \'-) ' '> c u +n'f Time line for the valuation of a stock |lhoJ<-\ tDC'cn') Period: CF: Hence, the value (PV) of a stock is: Stockvalue, 4= Ptt = .;?' ,+ ::!' ,; *."*-2t- (l +{r) (l+t)' (l+rr)- : the sum of discounted future dividends : Called, 'Dividend discount model' or 'Dividend groMh model' There are three cases for the stock valuation depending on the growth of dividends follows: Case 1: Normal, or Constanl, growth 9f dividends, the growth rate is denoted by g, and s +0. D.., D.' .,i5-- ,'r-": c'' u*-1,. 6 ? v' D1, D , a..\$ o.-- o" fr-1)- Case2: No groMhofdividends, g=0. --D Di''='i)r -- br-.-" ' Case 3: Nonconstant growth of dividends, gsupER and gNonv such that gsupsn > gNonlr. (\.- 71*) -.1 J
f _, -- <-e\.,-r n 2. Stockvaluationof case 1(g*0) :-1.-g-,* \.., ./ t) Three types of rates of retum on the stock Required rate of return ( t = /nr * (r" - r*.)F, from chapter g) l) r" is a value you require based ofi rpp and the risk of the stock.

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