week 07 Equity Valuation

week 07 Equity Valuation - Equities Equities Equity...

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quities Equities Equity Valuation
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Today ± Constant growth dividend discount models ± Multi-stage DDM ± Estimating growth rate ± Other ad-hoc models ± Examples Week 7 FINS5513 2
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Dividend Discount Models ± Holding a stock for one year: + + 1 1 Dividend P D P == ++ 11 0 V 1 discount rate 1 k ± If sold for P 1 = V 1 = (D 2 +P 2 )/(1+k), then + =+ + + 12 2 0 2 DD P V 1k ( ) ± Continue for P = V , P = V , . .... Week 7 FINS5513 3
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Dividend Discount Models =+ + + = ++ + + t 3 12 o 23 t 1 D DD D V. . . 1k ( )( ) ± Intrinsic value = present value of all future dividends = t1 () ± Discount rate k is the required return estimated from the CAPM ± No need to predict price ± Need to forecast dividends Week 7 FINS5513 4
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Constant Growth Model ± Dividends grow at a constant rate g 3 ++ + =+ + + + 23 00 0 o D(1 g )D ( 1 g ( 1 g) V ... 1 k (1 k) = + + == = +− t 0 1 0 t t1 D(1 g) 1g D D k g k g ± If g = 0 (constant dividend), V 0 = D/k Week 7 FINS5513 5
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An Example ± Assume D 0 =$1.50, g=8%, β =1.2, r f =5%, E(r M ) = 13%. ± k = r f + β [E(r M )-r f ] = 5%+1.2 × 8% = 14.6% g 1 0 8 + == × = −− o 0 1g .08 V D 1.5 $24.55 kg 0 . 1 4 60 . 0 8 Week 7 FINS5513 6
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Using the Constant Growth Model ± V 0 = D 1 /(k–g) ± It is common to set V 0 = P 0 (current market price) and solve for D 1 , k or g to find out what are the market’s expectations iven V r P what assumptions about D k or g are ± Given V 0 or P 0 , what assumptions about D 1 , k or g are necessary to justify this value.
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week 07 Equity Valuation - Equities Equities Equity...

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