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03rec3

# 03rec3 - 15.407 Recitation October 2 2003 MIT Sloan School...

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15.407 Recitation October 2, 2003

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MIT Sloan School of Management Things to cover today: Pricing Risky Cashflows: 1. DDM 2. Financial Ratios 3. Examples 4. Past Problem Sets (PS1 Q4, PS2 Q6)
DDM: The idea of DDM is: P t = E t [ D t +1 + P t +1 1+ r t +1 ] Where r t +1 is a discount rate specific to the cashflow. If we assume that the discount rate is fixed for each period, then by using the for- mula for P t +1 , P t +2 , ... we arrive at the DDM model: P t = τ =1 E t [ D t + τ ] (1+ r t + τ ) τ Common names for r t : Risk Adjusted Discounted Rate Market Capitalization Rate Cost of Capital Required Rate of return

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Special Cases: Constant discount rates and growth: P 0 = E 0 [ D 1 ] r - g This is the Gordon Growth Formula Multiple-stage Growth: E.g. Company grows at 20% for first 5 years, then slow down to 10%. (i)Use the Gordon Growth formula to get the value of company 5 years from now. (ii)Discount the dividends and the FV of the company back to today. Plowback: Consider a company with gross earning of \$20, and initial dividend of \$10 (i.e. payout ratio of 50%).
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03rec3 - 15.407 Recitation October 2 2003 MIT Sloan School...

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