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week 07 Equity Valuation - Equities Equities Equity...

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Equities E it V l ti Equity Valuation
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T d 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 M d l Models H ldi t k f Holding a stock for one year: + + 1 1 1 Dividend P D P V = = + + 0 1 discount rate 1 k If sold for P 1 = V 1 = (D 2 +P 2 )/(1+k), then + = + + + 1 2 2 0 2 D D P V 1 k (1 k) Continue for P 2 = V 2 , P 3 = V 3 , ..... Week 7 FINS5513 3
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Dividend Discount M d l Models = = + + + = + + + + t 3 1 2 o 2 3 t t 1 D D D D V ... 1 k (1 k) (1 k) (1 k) Intrinsic value = present value of all future dividends Discount rate k is the required return estimated from the CAPM d di i No need to predict price Need to forecast dividends Week 7 FINS5513 4
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Constant Growth M d l Model Dividends grow at a constant rate g 2 3 D (1 ) D (1 ) D (1 ) + + + = + + + + + + 0 0 0 o 2 3 D (1 g) D (1 g) D (1 g) V ... 1 k (1 k) (1 k) = + + = = = + t 0 1 0 t t 1 D (1 g) 1 g D D (1 k) k g k g If g = 0 (constant dividend), V 0 = D/k Week 7 FINS5513 5
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A E l An Example $ Assume D 0 =$1.50, g=8%, β =1.2, r f =5%, E(r M ) = 13%. k + β [E( ) ] 5%+1 2 8% 14 6% k = r f [E(r M )-r f ] = 5%+1.2 × 8% = 14.6% + 1 g 1 08 = = × = o 0 1.08 V D 1.5 $24.55 k g 0.146 0.08 Week 7 FINS5513 6
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Using the Constant G h M d l Growth Model V 0 = D 1 /(k–g) It is common to set V 0 = P 0 (current market price) d l f D k t fi d t h t th and solve for D 1 , k or g to find out what are the market’s expectations Given V or P what assumptions about D k or g are 0 0
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