ch%208%20(Stock%20Valuation)[1]

ch%208%20(Stock%20Valuation)[1] - 8 Stock Valuation Common...

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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.

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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 1 = + = = P
Slide 8 - 4 Dividend and Stock Price You could continue to push back the year in which you will sell the stock. Then, you would find that the price of the stock is really just the present value of all expected future dividends. where, t = time horizon for your investment. The value of a stock is the present value of the dividends it will pay over the investor’s horizon plus the present value of the expected stock price at the end of that horizon. Dividend Growth Model () t t t R P D ... R D R D = ... R D R D R D = P + + + + + + + + + + + + + 1 1 1 1 1 1 2 2 1 3 3 2 2 1 0 Slide 8 - 5 How to Estimate All Future Dividend Payments? When you 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. Estimating Dividends: Special Cases Constant dividend : The firm will pay a constant dividend forever; the price is computed using the perpetuity formula Constant dividend growth : Dividend will increase by a constant percent every period Two-stage growth : Dividend will grow at one rate for some years and then grow at another rate thereafter forever

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ch%208%20(Stock%20Valuation)[1] - 8 Stock Valuation Common...

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