equities

equities - Equity Valuation Models 1 Common Stocks...

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1 Equity Valuation Models 2 Common Stocks • Shareholders own the firm • Shares are residual claims on the firm (after bondholders) • Shareholders receive as cash flows: – dividends (timing and magnitude uncertain) – capital gains (ditto) Tradeoffs between Stocks and Bonds Stocks Bonds -- dividend cash flows not -- coupon flows are certain (except in guaranteed case of default) -- capital gains flows depend on -- principal repayment timing and stock price magnitude are known -- residual claim in the event of -- first claim in bankruptcy bankruptcy
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3 + + D 1 (1+R) D 2 (1+R) 2 D 3 (1+R) 3 P 0 = + . .. Alternatively: given a 1 year investment horizon…. + D 1 (1+R) P 1 (1+R) P 0 = … and the next purchaser's horizon is also one year. .. + D 2 (1+R) 2 P 2 (1+R) 2 P 1 = … continuing indefinitely, we end up as before. => + D 1 (1+R) D 2 + P 2 (1+R) 2 P 0 = Stock Price Valuation Current stock price = discounted PV of expected future dividends 4 Constant Growth Formula for Stocks Frequently it is convenient to make the assumption that dividends will grow at a constant rate forever: D 2 = D 1 (1+g) D t = D t-1 (1+g) = D 0 (1+g) t + + D 1 (1+R) D 1 (1+g) (1+R) 2 D 1 (1+g) 2 (1+R) 3 + . .. Hence:
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equities - Equity Valuation Models 1 Common Stocks...

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