BCOR 2200 Chapter 7 w cq

BCOR 2200 Chapter 7 w cq - Chapter 7 Equity Markets & Stock...

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1 Chapter 7 Equity Markets & Stock Valuation

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2 Outline: 1. Common Stock Valuation 2. Features of Common and Preferred Stocks 3. The Stock Markets Concepts and Skills: Stock prices depend on: 1. Future dividends 2. The growth rate of those dividends Compute stock prices using the dividend growth model Understand how corporate directors are elected Understand how stock markets work Understand how stock prices are quoted
3 7.1 Common Stock Valuation Share of Ownership Entitles you to: 1. Share of Profits 2. Share of Equity (Equity = Assets – Liabilities) If the company is liquidated (which means the assets are sold) And creditors (including bond holders) get their money What is left (the residual ) goes to the shareholders So shares of stock are sometimes called residual claims 3. Share of vote for Board of Directors Stock is worth the PV the money that received: 1. Dividends paid to shareholders while the stock is held 2. Cash from the sale of the stock

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4 Example: A stock is held for 1 year: It will pay a \$2 dividend in one year It can be sold for \$14 in one year The required return is 20% on investments with this risk Calculate the most you are willing to pay: P 0 = Price at time 0 D 1 = Dividend at time 1 P 1 = Price at time 1 ( 29 ( 29 33 . 13 \$ 0 2 . 1 14 \$ 2 \$ R 1 P D P 1 1 1 1 0 = + = + + =
5 Example: Same stock is held for 2 years: Div at time 2 = \$2.10 D 1 = \$2.00 and D 2 = \$2.10 Price at time 2 = P 2 = \$14.70 Still require a 20% return Cash flow diagram: ( 29 ( 29 ( 29 ( 29 33 . 13 \$ 0 2 . 1 70 . 14 \$ 10 . 2 \$ 0 2 . 1 2 \$ R 1 P D R 1 D P 2 1 2 2 2 1 1 0 = + + = + + + + = P 0 \$14.70 0 1 2 \$2.00 \$2.10

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Clicker Question: A share of stock will pay a \$1 dividend in one year and a \$1.25 dividend in two years. The price of the stock at time 2 will be \$25 Calculate the current price of the stock assuming a required return of 10% A. \$20.00 B. \$21.69 C.\$22.60 D.\$24.77 E. \$27.25 6
Clicker Answer: D 1 = \$1 D 2 = \$1.25 P 2 = \$25 R = 10% P 0 = D 1 /(1 + R) + (P 2 + D 2 )/(1 + R) 2 = \$1/(1.1) + (\$25 + \$1.25)/(1.1) 2 = \$0.91 + \$21.69 = \$22.60 The answer is C. 7

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8 General Formula For a Stock’s Price: • The price at any time (including now, P 0 ) is the present value of all future cash flows For a stock the CFs are called dividends But if we sell the stock… Then we get the Price at the time it is sold How do we calculate the price at the time of sale? ( 29 ( 29 ( 29 ( 29 + + + + + + + + = 4 4 3 3 2 2 1 0 R 1 D R 1 D R 1 D R 1 D P
9 Derivation of General Formula (Part 1): P 0 is a function of D and P But P is a function of D and P . ( 29 R 1 P D P 2 2 1 + + = ( 29 R 1 P D P 1 1 0 + + = ( 29 ( 29 ( 29 ( 29 2 2 2 1 1 0 2 2 1 0 R 1 P D R 1 D P R 1 R 1 P D D P + + + + = + + + + =

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10 Derivation of General Formula (Part 2): So now P 0 is a function of D , D and P ( 29 R 1 P D P 3 3 2 + + = ( 29 ( 29 2 2 2 1 1 0 R 1 P D R 1 D P + + + + = ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 3 3 3 2 2 1
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This note was uploaded on 12/06/2010 for the course BCOR 2200 at Colorado.

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BCOR 2200 Chapter 7 w cq - Chapter 7 Equity Markets & Stock...

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