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Ch.6. Stock Valuation - Lecture Summary

# Ch.6. Stock Valuation - Lecture Summary - Ch.5 Stock...

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Ch.5. Stock Valuation – Lecture Summary Dividend Yield – a measure of return for a stock (equity) investment where: Dividend Yield (DY) = annual dividend payment (DIV) stock price (P 0 ) Example: #7 Text: BMM Industries pays a dividend of \$2 per quarter. The dividend yield on its stock is 4.8%. What is the current stock price? Solution: Annualize the dividend and solve the above equation for P 0 P 0 = DIV / DY = (\$2 x 4) / 0.048 = \$166.67 Q: Why is the dividend yield calculation an inadequate measure of return for stocks? A: It does not take into account any capital gains or capital losses! Background for DDM Price of Stock (or Bond) Today = P 0 = PV future cash flows i.e. Expected return = r = DIV yield + Price yield r = DIV 1 / P 0 + (P 1 – P 0 ) / P 0 r = (DIV 1 + P 1 ) / P 0 Solving for P 0 = (DIV 1 + P 1 ) / (1 + r ) 1 i.e. current stock price is equal to next year’s dividend (DIV 1 ) plus next year’s price (P 1 ), discounted by the required rate of return (r). Example : Copper Inc.’s dividend next year will be \$5 per share. The forecast stock price next year is \$105. Equally risky stocks of other companies offer expected returns of 10%. What should Copper Inc.’s stock sell for?

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