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Chap008 - Chapter 8 Stock Valuation How big The 30 stocks...

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Chapter 8 Stock Valuation
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How big? The 30 stocks of the DJIA account for $2.34T (2/24/09), down from $3.6T (9/29/2008). The largest stock is Exxon Mobil at $350 ($409B) in market cap, followed by Wal-Mart at $194B ($237B), Microsoft at $152B ($245B), Johnson and Johnson at $150B ($194B), Proctor and Gamble at $144B ($208B), AT&T at $133B ($172B), Chevron at $129B ($171B), IBM at $112B ($157B), Coca Cola at $98B, and GE at $92B ($247B). Among financials J.P. Morgan is on top at $76B ($157B), BofA at $20B, American Express at $14B and Citigroup at $12B. GM is the smallest at $1.1B ($5.5B). Off the DJIA, GS is worth $38B, MS $20B
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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
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Developing The Model The price of a stock, like any asset, is the present value of all its expected future cash flows. Specifically, for a stock, it is the present value of all expected future dividends So, how can we estimate all future dividend payments?
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Estimating Dividends: 3 Cases Constant dividend The firm will pay a constant dividend forever This is like preferred stock The price is computed using the perpetuity formula Constant dividend growth The firm will increase the dividend by a constant percent every period Supernormal growth Dividend growth is not consistent initially, but settles down to constant growth eventually
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Constant Dividend (Zero Growth) If dividends are expected at regular intervals forever, then this is a perpetuity and the present value of expected future dividends can be found using the perpetuity formula – P 0 = D / R Suppose stock is expected to pay a $0.50 dividend every quarter and the required return is 10% with quarterly compounding.
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