chap8

# chap8 - Chapter 8 Stock Valuation FIN 3716 Key Concepts and...

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Chapter 8 Stock Valuation FIN 3716

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8-2 FIN 3716 Key Concepts and Skills Key Concepts and Skills Understand how stock prices depend on future dividends and dividend growth Be able to 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
8-3 FIN 3716 Chapter Outline Chapter Outline Common Stock Valuation Some Features of Common and Preferred Stocks The Stock Markets

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8-4 FIN 3716 Cash Flows for Stockholders Cash Flows for Stockholders If you buy a share of stock, you can receive cash in two ways The company pays dividends You sell your shares, either to another investor in the market or back to the company As with bonds, the price of the stock is the present value of these expected cash flows
8-5 FIN 3716 One-Period Example One-Period Example Suppose you are thinking of purchasing the stock of Moore Oil, Inc. and 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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8-6 FIN 3716 Two-Period Example 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
8-7 FIN 3716 Three-Period Example 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? PV = 2 / 1.2 + 2.10 / (1.2) 2 + (2.205 + 15.435) / (1.2) 3 = 13.33

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8-8 FIN 3716 Developing The Model Developing The Model You could continue to push back the year in which you will sell the stock You would find that the price of the stock is really just the present value of all expected future dividends So, how can we estimate all future dividend payments?
8-9 FIN 3716 Estimating Dividends: Special Cases Estimating Dividends: Special Cases Constant dividend The firm will pay a constant dividend forever This is like preferred stock The price is computed using the perpetuity formula

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## This note was uploaded on 12/14/2010 for the course FIN 3716 taught by Professor Fang during the Fall '10 term at LSU.

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chap8 - Chapter 8 Stock Valuation FIN 3716 Key Concepts and...

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