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Unformatted text preview: Chapter 6 Stock Valuation 62 Chapter Outline 6.1 The Present Value of Common Stocks 6.2 Dividend Discount Model Parameters 6.3 Growth Opportunities 6.4 Dividend Growth and NPVGO 6.5 PriceEarnings Ratio 6.6 Common and Preferred Stocks 6.7 The Stock Markets 63 Key Concepts and Skills • Understand how stock prices depend on future dividends and dividend growth • Compute stock prices using the dividend growth model • Understand how growth opportunities affect stock values • Understand the PE ratio • Understand how stock markets work 64 6.1 The PV of Common Stocks • The value of any asset is the present value of its expected future cash flows. • Stock ownership produces cash flows from: – Dividends – Capital Gains • Valuation of Different Types of Stocks – Zero Growth – Constant Growth – Differential Growth 65 Case 1: Zero Growth • Assume that dividends will remain at the same level forever r P r r r P Div ) 1 ( Div ) 1 ( Div ) 1 ( Div 3 3 2 2 1 1 = + + + + + + = = = = 3 2 1 Div Div Div • Since future cash flows are constant, the value of a zero growth stock is the present value of a perpetuity : 66 Case 2: Constant Growth ) 1 ( Div Div 1 g + = • Since future cash flows grow at a constant rate forever, the value of a constant growth stock is the present value of a growing perpetuity : g r P = 1 Div • Assume that dividends will grow at a constant rate, g , forever 2 1 2 ) 1 ( Div ) 1 ( Div Div g g + = + = 3 2 3 ) 1 ( Div ) 1 ( Div Div g g + = + = 67 Constant Growth Example • Suppose Big D, Inc., just paid a dividend of $.50. It is expected to increase its dividend by 2% per year. • If the market requires a return of 15% on assets of this risk level, at what price should the stock sell?...
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This note was uploaded on 10/16/2011 for the course FIN 357 taught by Professor Hadaway during the Spring '06 term at University of Texas.
 Spring '06
 Hadaway
 Corporate Finance, Valuation

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