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Chap008

# Chap008 - C hapter 8 Stock Valuation Key Concepts and...

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Chapter 8 Stock Valuation

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Key Concepts and Skills Understand how stock prices depend on future dividends and dividend growth Be able to compute stock prices using the dividend growth model Understand how corporate directors are elected Understand how stock markets work Understand how stock prices are quoted 8-2
Chapter Outline Common Stock Valuation Some Features of Common and Preferred Stocks The Stock Markets 8-3

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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, 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 8-4
One-Period Example Suppose you are thinking of purchasing the stock of Moore Oil, Inc. 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 FV = 16; I/Y = 20; N = 1; CPT PV = -13.33 8-5

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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 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? PV = 2 / (1.2) + (2.10 + 14.70) / (1.2) 2 = 13.33 8-6
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 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 be \$15.435. Now how much would you be willing to pay? PV = 2 / 1.2 + 2.10 / (1.2) 2 + (2.205 + 15.435) / (1.2) 3 = 13.33 8-7

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Developing The Model You could continue to push back the year in which you will sell the stock You would find that the price of the stock is really just the present value of all expected future dividends So, how can we estimate all future dividend payments?
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