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Unformatted text preview: 61Common Stock Valuation•Our goal in this chapter is to examine the methods commonly used by financial analysts to assess the economic value of common stocks.•These methods are grouped into two categories:–Dividend discount models–Price ratio models–Most importantly: Fundamental Analysis62The Dividend Discount Model•In the DDM equation:–V(0) = the present value of all future dividends–D(t) = the dividend to be paid tyears from now–k = the appropriate riskadjusted discount rate( 29( 29( 29( 29T32k1D(T)k1D(3)k1D(2)k1D(1)V(0)+++++++=63Example: The Dividend Discount Model•Suppose that a stock will pay three annual dividends of $200 per year, and the appropriate riskadjusted discount rate, k, is 8%.•In this case, what is the value of the stock today?( 29( 29( 29( 29( 29( 29$515.420.081$2000.081$2000.081$200V(0)k1D(3)k1D(2)k1D(1)V(0)3232=+++++=+++++=64The Dividend Discount Model:the Constant Growth Rate Model•Assume that the dividends will grow at a constant growth rate g. •Then, the dividend next period (t + 1) is:•In this case, the DDM formula becomes:gkifD(0)TV(0)gkifk1g11gkg)D(0)(1V(0)T=×=≠+++=( 29 ( 29 ( 29g1tD1tD+×=+65Example: The Constant Growth Rate Model•Suppose the current dividend is $10, the dividend growth rate is 10%, there will be 20 yearly dividends, and the appropriate discount rate is 8%. •What is the value of the stock, based on the constant growth rate model?( 29( 29$243.861.081.101.10.081.10$10Vgkifk1g11gkg)D(0)(1V(0)20T=×=≠+++=66The Dividend Discount Model:the Constant Perpetual Growth Model. •Assuming that the dividends will growforeverat a constant growth rate g.•In this case, the DDM formula becomes:( 29( 29 ( 29( 29kggk1Dgkg1DV<=+×=67Example: Constant Perpetual Growth Model•Think about the electric utility industry. •In mid2003, the dividend paid by the utility company, American Electric Power (AEP), was $1.40.•Using D(0)=$1.40, k = 6.5%, and g = 1.5%, calculate an estimated value for AEP.•Note: the actual mid2003 stock price of AEP was $25.88.( 29( 29$28.42.015.0651.015$1.40V=×=68The Historical Average Growth Rate•Suppose the Kiwi Company paid the following dividends:–1998: $1.502001: $1.80–1999: $1.702002: $2.00–2000: $1.752003: $2.20•The spreadsheet below shows how to estimate historical average growth rates, using arithmetic and geometric averages.Year:Dividend:Pct. Chg:2003$2.2010.00%2002$2.0011.11%2001$1.802.86%Grown at2000$1.752.94%Year:7.96%:1999$1.7013.33%1998$1.501998$1.501999$1.622000$1.758.05%2001$1.892002$2.047.96%2003$2.20Arithmetic Average:Geometric Average:69The Sustainable Growth Rate•Return on Equity (ROE) = Net Income / Equity•Payout Ratio = Proportion of earnings paid out as dividends•Retention Ratio = Proportion of earnings retained for investmentRatio)Payout(1ROERatioRetentionROERateGrowtheSustainabl×=×=610...
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This note was uploaded on 05/27/2011 for the course ACCOUNTING 000111102 taught by Professor Dr.majedqbajeh during the Spring '11 term at Philadelphia.
 Spring '11
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