Chapter_8_FI311_FA2011_SS

Chapter_8_FI311_FA2011_SS - Click to edit Master title...

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Unformatted text preview: Click to edit Master title style 10/25/11 1 10/25/11 Chapter 8 Stock Valuation Click to edit Master title style 10/25/11 2 10/25/11 Key Concepts and Skills • Understand how stock prices depend on future dividends and dividend growth • Be able to compute stock prices using the dividend growth model • Understand how corporate directors are elected • Understand how stock markets work • Understand how stock prices are quoted Click to edit Master title style 10/25/11 3 10/25/11 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 • Some companies don’t pay dividends (e.g. Apple). What drives the price of the stock in that case? Click to edit Master title style 10/25/11 4 10/25/11 One-Period Example • 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 = 14; PMT = 2; I/Y = 20; N = 1; CPT PV = -13.33 Click to edit Master title style 10/25/11 5 10/25/11 Two-Period Example 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 Or: CF = 0; C01 = 2; F01 = 1; C02 = 16.80; F02 = 1; NPV; I = 20; CPT NPV = 13.33 Click to edit Master title style 10/25/11 6 10/25/11 Three-Period Example 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 receive a dividend of $2.205 at the end of year 3 and the stock price is expected to be $15.435. Now how much would you be willing to pay? PV = 2 / 1.2 + 2.10 / (1.2) 2 + (2.205 + 15.435) / (1.2) 3 = 13.33 Or: CF = 0; C01 = 2; F01 = 1; C02 = 2.10; F02 = 1; C03 = 17.64; F03 = 1; NPV; I = 20; CPT NPV = 13.33 Click to edit Master title style 10/25/11 7 10/25/11 Stock Valuation Models The value of a share of common stock can be viewed as the discounted value of all expected future dividends provided by the issuing firm: Where: D t = cash dividend at the end of period t r = required return ∑ ∞ = ∞ ∞ + = + + + + + + + + = 1 3 3 2 2 1 1 ) 1 ( ) 1 ( ......
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This note was uploaded on 10/25/2011 for the course FI 311 taught by Professor Booth during the Fall '06 term at Michigan State University.

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Chapter_8_FI311_FA2011_SS - Click to edit Master title...

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