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Chapter 8 notes - Chapter 8.1 Common Stock Valuation Common...

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Chapter 8.1: Common Stock Valuation Common stock is more difficult to value than bonds for 3 reasons: 1. Not even the promised cash flows are known in advance 2. The life of the investment is basically forever because common stock has no maturity 3. There is no way to easily observe the rate of return the market requires We can push the problem of coming up with the stock price off into the future forever o No matter what the stock price is the present value is essentially zero SO current price of the stock can be written as the present value of the dividends beginning in one period and extending out forever In a few special cases we can come up with a value for a stock o We just have to make some assumptions about future dividends, either of these 3 cases are plausible: The dividend has a zero growth rate The dividend grows at a constant rate The dividend grows at a constant rate after some length of time Zero Growth means the dividend is constant through time
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