4. FIN 301-F08 Lab 4 Equity

4. FIN 301-F08 Lab 4 Equity - Equity Seminar4...

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Equity Seminar 4 Equity Valuation, NPVGO and P/E Ratio

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Cash Flows for Shareholders 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  2
One Period Example Suppose you are thinking of purchasing  the stock of Moore Oil, Inc. You plan to  hold the stock for one year. Expect dividend (D 1 )   = \$2 Expected Price (P 1 )   = \$14 If you require a return of 20%, 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 3

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Two Period Example Now what if you decide to hold the stock  for two years?  Expect dividend (D 2 )   = \$ 2.1 Expected Price (P 2 )   = \$14.7 How much would you be willing to pay  now? PV = 2 / (1.2) + (2.10 + 14.70) / (1.2) 2          = 13.33 4
Stock Valuation Stock Valuation Stock Value = Present Value (Expected Cashflows) Basic models can be obtained with simplifying  assumptions. 1. Constant Dividends  – A Perpetuity 1. Constant Growth in Dividends  – A Growing Perpetuity 2. Combinations  – Draw a Timeline and See! Check the example out…  r D r) (1 D P 1 t 0 = + = = t g - r D r) (1 g) (1 D P 1 1 t t 0 0 = + + = = t Gordon Growth Formula, 1962 Gordon Growth Formula, 1962 Prof. Gordon, University of Toronto Prof. Gordon, University of Toronto 5

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Miracle Grow Inc.’s  first dividend of \$4 per  share  is expected to be paid  six years from  today From then on, dividends will grow by  15%  per  year for  five years The growth rate will then slow down to  5%  per  year forever.  The required return on Miracle stock is  10%   (EAR).  What is the value of a share of Miracle stock  today? 6
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This note was uploaded on 11/01/2011 for the course BUSINESS FIN301 taught by Professor Andrew during the Fall '10 term at University of Alberta.

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4. FIN 301-F08 Lab 4 Equity - Equity Seminar4...

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