Chapter 8

Chapter 8 - Stock Valuation - Chapter 8 Yihui Wang Stock...

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Stock Valuation -- Chapter 8 Yihui Wang Stock Valuation
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Main Issues • Stock valuation Dividend discount model Comparables approach (market approach) • Important features of common stock • The stock markets Stock Valuation 2
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What is Common Stock ommon stock: Common stock: is a certificate of ownership in a corporation. represents a claim against the residual value of the firm, which is the value after all other claimants are getting paid. • Payments to common stock are dividends f di id d i i b h Payments of dividend are uncertain in both magnitude and timing (contrary to bond) vailable cash on hand Available cash on hand Terms of relevant debt contract Investment opportunity Stock Valuation 3
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Cash Flows of Stockholders •I f you buy a share of stock, you can receive cash in two ways: he company pays dividends 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. The difference is that cash flows of stocks are much more uncertain arder to predict future cash flows Stock Valuation Harder to predict future cash flows Adjust discount rate to reflect the uncertainty 4
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One Period Example • Suppose you are thinking of purchasing the stock of Moore Oil, Inc. and you expect it to pay a $2 id d i d b li h ll dividend in one year and you believe that you can sell the stock for $14 at that time. If you require a return 20% on investments of this risk what is the of 20% on investments of this risk, what is the maximum you would be willing to pay? ) 1 ( ) 1 ( 1 1 0 R P R D PV P + + + = = Stock Valuation 5
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Two Period Example ** • Now what if you decide to hold the stock for two years? In addition to the dividend in one year, you di id d f $2 10 i d k 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 ould you be willing to pay? would you be willing to pay? P D D V 2 2 2 2 1 0 ) 1 ( ) 1 ( ) 1 ( R R R PV P + + + + + = = Stock Valuation 6
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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 d 2 i di id d f $2 205 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 $15 435 Now how much would you be willing to be $15.435. Now how much would you be willing to pay? 3 3 3 2 1 0 ) 1 ( ) 1 ( ) 1 ( ) 1 ( 3 2 R P R D R D R D PV P + + + + + + + = = Stock Valuation 7
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Developing The Model • You could continue to push back when you would sell the stock • You would find that the price of the stock is really just the present value of all expected future dividends L + + + + + + + + + + = = 5 5 4 4 3 3 2 2 1 0 ) 1 ( ) 1 ( ) 1 ( ) 1 ( ) 1 ( R D R D R D R D R D PV P •T w o important inputs Future dividends Stock Valuation Discount rate 8
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Modeling Dividend onstant dividend Constant dividend The firm will pay a constant dividend forever, like preferred stock The price is computed using the perpetuity formula pp g p p y • Constant dividend growth
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Chapter 8 - Stock Valuation - Chapter 8 Yihui Wang Stock...

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