2504c_1018 - BUSI 2504c - Essentials of Business Finance...

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Unformatted text preview: BUSI 2504c - Essentials of Business Finance Monday, October 18, 2010 18:15-18:45 Quiz #2 8 Stocks 3 rd hour More examples announcements quiz #3 next monday, october 25 chapter 8 only BUSI 2504c Monday, October 18, 2010 2 / 36 chapter 8: stocks 8.1 - Common Stock Valuation 8.2 - Common Stock Features 8.3 - Preferred Stock Features 8.4 - Stock Market Reporting BUSI 2504c Monday, October 18, 2010 3 / 36 8.1: cash flows for shareholders If you buy a share of stock, you can receive cash in two ways The company pays dividends You sell your shares, either: (1) to another investor in the market; or (2) back to the company As with bonds, the price of the stock is the present value of these expected cash flows BUSI 2504c Monday, October 18, 2010 4 / 36 8.1: stock price - 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? answer : $13.33 BUSI 2504c Monday, October 18, 2010 5 / 36 8.1: stock price - two period example Now what if you decide to hold the stock for two years? In addition to the $2 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 now? answer : $13.33 BUSI 2504c Monday, October 18, 2010 6 / 36 8.1: stock price - three period example Finally, what if you decide to hold the stock for three periods? 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 a stock price of $15.435. Now how much would you be willing to pay? answer : $13.33 BUSI 2504c Monday, October 18, 2010 7 / 36 8.1: dividend growth model Zero growth The firm will pay a constant dividend forever This is like preferred stock The price is computed using the perpetuity formula Constant growth The firm will increase the dividend by a constant percent every period Supernormal growth Dividend growth is not consistent initially, but settles down to constant growth eventually BUSI 2504c Monday, October 18, 2010 8 / 36 8.1: dividend growth model - general case present value of single cash flow PV = FV ( 1 + r ) t price today ( P ) is present value of all future dividends D 1 , D 2 , D 3 , . . . P = D 1 1 + r + D 2 ( 1 + r ) 2 + D 3 ( 1 + r ) 3 + . . . BUSI 2504c Monday, October 18, 2010 9 / 36 8.1: dividend growth model - zero growth zero growth (all future dividends are equal) price today ( P ) is present value of all future dividends D 1 , D 2 , D 3 , . . ....
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2504c_1018 - BUSI 2504c - Essentials of Business Finance...

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