BFIN620_PPT_CH6_sp09-8

BFIN620_PPT_CH6_sp09-8 - 61 Business Finance 620 Stock...

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6 1 Stock Valuation Stock Valuation and Market Efficiency and Market Efficiency Chapter 6 Brealey-Myers-Marcus 5 th Edition Business Finance 620
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6 2 Topics Covered Comparing bonds and stocks Stocks and the stock market Expected return Common stock valuation Dividend Discount Model (DDM) Simplifying the Dividend Discount Model Sustainable growth Sources of stock value Income stocks and growth stocks Present value of growth opportunities (PVGO) Market efficiency
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6 3 Comparing Bonds and Stocks Corporate bonds Fixed maturity Guaranteed periodic income payment Guaranteed sale price at maturity Limited ability to control sale price before maturity Common stock Uncertain maturity (as long as firm is going concern) Uncertain periodic dividend payment (may be none) Uncertain future sale price
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6 4 Stocks and the Stock Market Quick Terminology Review Primary market Initial public offering Seasoned offering Secondary market Common stock and preferred stock Cash dividend Standards of equity value Book value Market value (“going concern”) Liquidation value
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6 5 Expected Rate of Return The percentage yield an investor anticipates from a specific investment over a set period of time. Can be rewritten to stress the 2 component yields: 0 0 1 1 P P P DIV Return of Rate Expected - + = 0 0 1 0 1 Return of Rate Expected P P P P DIV - + = Dividend Yield Capital Gains Yield (positive or negative)
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6 6 Dividend Discount Model (DDM) The price (share value) today equals the PV of all expected dividends over the holding period: where: P 0 is the price (share value) today DIV is the periodic cash dividend (may vary) R is the investor’s required rate of return H is the investment horizon (“holding period”) P H is the sale price at the end of the holding period H H H 2 2 1 1 0 R) (1 P DIV ... R) (1 DIV R) (1 DIV P + + + + + + + =
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Dividend Discount Model (DDM) Application ABC Products plans to pay the following cash dividends at the end of the next 3 years: Year 1 = $3.00 Year 2 = $3.24 Year 3 = $3.50 At the end of this period the stock can be sold for $94.48. If investors demand a 12% return, how much is the stock worth today?
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BFIN620_PPT_CH6_sp09-8 - 61 Business Finance 620 Stock...

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