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393_lecture9 - Stock Valuation Lecture 9 Myung Joo Song...

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Stock Valuation Lecture 9 Myung Joo Song ECON 393 Fall 2011 Myung Joo Song (ECON 393) Stock Valuation Fall 2011 1 / 26
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Chapter Outline Common Stock Valuation using Present Value Model. Some Features of Common and Preferred Stocks. The Stock Markets. Myung Joo Song (ECON 393) Stock Valuation Fall 2011 2 / 26
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Value Stock as an Asset Now you are an expert in Present Value (PV) model. You also have a big example of Bond. Use PV to value stock, an asset giving future incomes and also is traded in the market. What do you need to value stock? - Structure of Future Cash Flows - Number of Period - Discount rate - Market required rate if traded in the market - or your subjective point of view Myung Joo Song (ECON 393) Stock Valuation Fall 2011 3 / 26
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Cash Flows for Stockholders Have a quick review on stock definition. Stock generates income and capital gains. If you buy stock today, you can receive; Dividends as income (Income Gain) Future price of stock once you sell it (Capital Gain) So, you need two things: There is no default. There is a market for the stock. What if you miss one of the two? What is different between stock and bond in term of cash-generating? Myung Joo Song (ECON 393) Stock Valuation Fall 2011 4 / 26
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Example: One-Period Suppose you are thinking of purchasing the stock of Moore Oil, Inc. You expect it to pay a $2 dividend in one year, and you believe that you can sell the stock for $14 at that time. If you require a return of 20% on investments of this risk, what is the maximum you would be willing to pay? Compute the PV of the expected cash flows. Price = (14 + 2) / (1.2) = $13.33 or FV = 16; I/Y = 20; N = 1; CPT, PV = -13.33 Myung Joo Song (ECON 393) Stock Valuation Fall 2011 5 / 26
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Example: Two-Period Now, what if you decide to hold the stock for two years? In addition to the dividend in one year, you expect a dividend of $2.10 in two years and a stock price of $14.70 at the end of year 2. Now how much would you be willing to pay? PV = 2 / (1.2) + (2.10 + 14.70) / (1 . 2) 2 = 13.33 Myung Joo Song (ECON 393) Stock Valuation Fall 2011 6 / 26
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Example: Three-Period Finally, what if you decide to hold the stock for three years? In addition to the dividends at the end of years 1 and 2, you expect to
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This note was uploaded on 10/25/2011 for the course ECON 393 taught by Professor D during the Spring '10 term at Rutgers.

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393_lecture9 - Stock Valuation Lecture 9 Myung Joo Song...

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