Chapter_7_Fall2011_s

Chapter_7_Fall2011_s - Chapter71 Chapter StockValuation...

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1 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 7 Stock Valuation Elizabeth Booth Chapter 7 Stock Valuation
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2 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 7 Stock Valuation Elizabeth Booth 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
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3 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 7 Stock Valuation Elizabeth Booth 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
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4 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 7 Stock Valuation Elizabeth Booth Common Stock Valuation No one method for stock valuation is universally accepted Most investors are more concerned about the impact of market changes on their entire portfolio, than they are about the valuation of one particular stock. This is in large part because it is advisable to own common stocks as part of a well diversified portfolio, and NOT as individual investments.
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5 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 7 Stock Valuation Elizabeth Booth Common Stock Valuation Assume: P 0 = current price of the stock P 1 = price of the stock one period from now r = required return in the market on this type of investment D 0 = current dividend D 1 = dividend one period from now The expected return from owning a share of stock for one period is: See lower part of p.198 for E(r ) equation
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6 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 7 Stock Valuation Elizabeth Booth Common Stock Valuation We can re write the formula as following: Expected returns = [ expected dividend yield] + [ expected capital gains yield]    0 0 1 0 1 P P P P D r E Dividend yield Capital gains yield
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7 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 7 Stock Valuation Elizabeth Booth Expected Return When the stock is priced correctly, the price (P 0 ) is equal to the present value of all future cash flows (dividends and capital gains). The expected return (Er) is the rate of return that investors require to compensate them for the inherent risk of owning the stock.
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8 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 7 Stock Valuation Elizabeth Booth Common Stock Valuation: Wastehaulers Example (pg. 198 199) 1. See P.198 for Problem 1 E(r) = D 1 + (P 1 –P 0 ) 1.20 + (44 – 42) = 7.62% P 0 42 Note: E(r) comes in 2 parts: dividend yield plus capital appreciation (capital gains yield).
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This note was uploaded on 11/09/2011 for the course FI 311 taught by Professor Booth during the Fall '06 term at Michigan State University.

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Chapter_7_Fall2011_s - Chapter71 Chapter StockValuation...

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