Ch11_Stock valuation and risk

# Ch11_Stock valuation and risk - Chapter11...

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Financial Markets and Institutions Chapter 11 Stock Valuation and Risk

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Financial Markets and Institutions Stock Valuation Methods Dividend discount model John Williams (1931) stated that the price of a  stock should reflect the present value of the  stock’s future dividends: = + = 1 ) 1 ( Price t t t k D k
Financial Markets and Institutions Stock Valuation Methods (cont’d) Dividend discount model (cont’d) For a constant dividend, the cash flow is a  perpetuity: For a constantly growing dividend, the cash  flow is a growing perpetuity: k D k D t t t = + = = 1 ) 1 ( Price g k D k D t t t - = + = = 1 1 ) 1 ( Price

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Financial Markets and Institutions Valuing A Stock Using the Dividend  Discount Model Example 1  : A firm is expected to pay a dividend  of \$2.10 per share every year in the   foreseeable future. Investors require a return  of 15% on the firm‘s stock. According to the  dividend discount model, what is a fair price ?for the firm‘s stock 14 \$ % 15 10 . 2 \$ ) 1 ( Price 1 = = = + = = k D k D t t t
Financial Markets and Institutions Valuing A Stock Using the Dividend  Discount Model Example 2  : A firm is expected to pay a dividend  of \$2.10 per share in one year. In every  subsequent year, the dividend is expected to  grow by 3 percent annually. Investors  require a return of 15% on the firm‘s stock.  According to the dividend discount model, ?what is a fair price for the firm‘s stock 50 . 17 \$ % 3 % 15 10 . 2 \$ ) 1 ( Price 1 1 = - = - = + = = g k D k D t t t

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Financial Markets and Institutions Stock Valuation Methods The price-earnings (PE) method assigns the  mean PE ratio based on expected earnings  of all traded competitors to the firm’s  expected earnings for the next year
Financial Markets and Institutions Valuing A Stock Using the PE Method  A firm is expected to generate earnings of \$2

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Ch11_Stock valuation and risk - Chapter11...

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