ffm1008SV - CHAPTER8 StocksandTheirValuation...

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    8-1 CHAPTER 8 Stocks and Their Valuation Features of common stock Determining common stock values Efficient markets Preferred stock
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8-2 Facts about common stock Represents ownership Ownership implies control Stockholders elect directors Directors elect management Management’s goal: Maximize the  stock price
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8-3 Social/Ethical Question Should management be equally concerned  about employees, customers, suppliers,  and “the public,” or just the stockholders? In an enterprise economy, management  should work for stockholders subject to  constraints (environmental, fair hiring, etc.)  and competition.
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8-4 Types of stock market  transactions Secondary market Primary market Initial public offering market (“going  public”)
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8-5 Value  Book value:       value of an asset as shown on a firm’s balance sheet;  historical cost. Liquidation value:       amount that could be received if an asset were sold  individually. Market value:       observed value of an asset in the marketplace;  determined by supply and demand. Intrinsic value :       economic or fair value of an asset; the present value  of the asset’s expected future cash flows.
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8-6 Security Valuation In general,  the  intrinsic value  of an asset  the  present value  of the stream of expected cash  flows discounted at  an appropriate  required rate of return . Can the intrinsic value  of an asset  differ from its market value ?
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8-7 Different approaches for valuing  common stock Dividend growth model Corporate value model Using the multiples of comparable  firms
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8-8 Dividend growth model Value of a stock is the present value of the  future dividends expected to be generated by  the stock. + + + + + + + + = ) k (1 D     ...     ) k (1 D     ) k (1 D     ) k (1 D     P s 3 s 3 2 s 2 1 s 1 0 ^
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8-9 Constant growth stock A stock whose dividends are expected to  grow forever at a constant rate, g. D 1  = D 0  (1+g) 1 D 2  = D 0  (1+g) 2 D t  = D 0  (1+g) t   If g is constant, the dividend growth formula  converges to: g   - k D     g   - k g) (1 D     P s 1 s 0 0 ^ = + =
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8-10 Future dividends and their  present values t 0 t   )   g     1   (   D D + = t t t )   k     1   ( D PVD + = t 0 PVD P = $ 0.25 Years (t) 0
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What happens if g > k s ? If g > k s , the constant growth formula  leads to a negative stock price, which  does not make sense. The constant growth model can only be 
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This note was uploaded on 12/12/2011 for the course ECONOMICS 101 taught by Professor Thoman during the Spring '09 term at Abu Dhabi University.

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ffm1008SV - CHAPTER8 StocksandTheirValuation...

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