July 7-1 - Equity Valuation Models (cont.) Efficient...

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Unformatted text preview: Equity Valuation Models (cont.) Efficient Markets Hypothesis (EMH) Three Forms Theoretical Foundations Empirical Foundations Empirical Challenges Theoretical Challenges Behavioral Finance Theoretical Challenges to EMH Categories of Investor Errors Portfolio Construction The Capital Allocation Decision One Risky and One Risk-Free Asset Calculating the Standard Deviation of the Portfolio Return The Capital Allocation Line (CAL) 1 2 1 2 ... (1 ) (1 ) (1 ) H H H D D D P V k k k + = + + + + + + P H = the expected sales price for the stock at time H H = the specified number of years the stock is expected to be held Specified Holding Period 1 (1 ) t o t t D V k = = + V = Value of Stock D t = Dividend k = required return Dividend Discount Models: General Model V D k o = Stocks that have earnings and dividends that are expected to remain constant Preferred Stock No Growth Model D = $5.00 k = .15 V = $5.00 /.15 = $33.33 V D k o = No Growth Model: Example (1 ) o o D g V k g + =- g = constant perpetual growth rate Constant Growth Model (1 ) o o D g V k g + =- g = constant perpetual growth rate k = required rate of return Constant Growth Model (1 ) o o D g V k g + =- g = constant perpetual growth rate k = required rate of return D = dividend in year 0 Constant Growth Model Vo D g k g o = +- ( ) 1 D = $3.00 k = 15% g = 8% V = 3.00 (1.08) / (.15 - .08) = $46.29 Constant Growth Model: Example g ROE b = g = growth rate in dividends ROE = Return on Equity for the firm b = plowback or retention percentage rate (1- dividend payout percentage rate) Estimating Dividend Growth Rates Dividend Growth for Two Earnings Reinvestment Policies Present Value of Growth Opportunities Continued Price = No-growth value per share + PVGO (present value of growth opportunities) 1 E P PVGO k = + ROE = 20% d = 60% b = 40% E 1 = $5.00 D 1 = $3.00 k = 15% g = .20 x .40 = .08 or 8% Partitioning Value: Example V NGV PVGO o o =- = = = =- = 3 15 08 86 5 15 33 86 33 52 (. . ) $42. . $33. $42. $33. $9. V o = value with growth NGV o = no growth component value PVGO = Present Value of Growth Opportunities Partitioning Value: Example Continued Financial Ratios in Two Industries P/E Ratios are a function of two factors Required Rates of Return (k) Expected growth in Dividends Uses Relative valuation Extensive Use in industry Price Earnings Ratios P E k P E k 1 1 1 = = E 1- expected earnings for next year E 1 is equal to D 1 under no growth k - required rate of return P/E Ratio: No Expected Growth 1 1 1 (1 ) ( ) 1 ( ) D E b P k g k b ROE P b E k b ROE- = =- - - =- b = retention ratio ROE = Return on Equity P/E Ratio: Constant Growth E = $2.50 g = 0 k = 12.5% P = D/k = $2.50/.125 = $20.00 PE = 1/ k = 1/.125 = 8 Numerical Example: No Growth b = 60% ROE = 15% (1- b ) = 40% E 1 = $2.50 (1 + (.6)(.15)) = $2.73 D 1 = $2.73 (1-.6) = $1.09 k = 12.5% g = 9% P = 1.09/(.125-.09) = $31.14 PE = 31.14/2.73 = 11.4 PE = (1 - .60) / (.125 - .09) = 11.4 Numerical Example: Growth P/E Ratios and Stock Risk...
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This note was uploaded on 10/21/2010 for the course ECON 1530 taught by Professor Ohly during the Spring '10 term at Dartmouth.

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July 7-1 - Equity Valuation Models (cont.) Efficient...

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