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ch 8 (Stock Valuation)

# ch 8 (Stock Valuation) - Common Stock Valuation Cash Flows...

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Chapter 8 Stock Valuation Slide 8 - 1 Common Stock Valuation Cash Flows for Stockholders If you buy a share of stock, you can receive cash in two ways: The company pays dividends; You sell your shares. Like bond valuation, the price of the stock is the present value of these expected cash flows . Unlike cash flows to bondholders, future cash flows to stockholders are uncertain. So the discount rate must reflect the risk associated with the cash flow uncertainty. Slide 8 - 2 Example: One Period Case 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? Compute the PV of the expected cash flows: Price = (14 + 2) / (1.2) = \$13.33 Or, by financial calculator: FV = 16; I/YR = 20; N = 1; PV = -13.33 Common Stock Valuation Slide 8 - 3 Common Stock Valuation Example: Two Period Case Now what if you decide to hold the stock for two years? In addition to the 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? Or, 33 . 13 2 . 1 14 2 1 14 2 . 1 7 . 14 1 . 2 1 1 1 0 2 2 1 = + = + + = = + = + + = R P D P R P D P ( ) 33 . 13 2 . 1 7 . 14 1 . 2 2 . 1 2 2 0 = + + = P

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