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Unformatted text preview: Lecture 11 Sections 6.4 and 6.5 : How to Value Bonds and Stocks (Corporate Finance by Ross et al.) ActSc 371 – Corporate Finance 1 Instructor: Dr. Lysa Porth 1 Introduction How to Value Bonds and Stocks • 6.4 The Present Value of Common Stocks • 6.5 Estimates of Parameters in the Dividend Discount Model 2 6.4 The Present Value of Common Stocks • The value of any asset is the present value of its expected future cash flows. • Stock ownership produces cash flows from: – Dividends – Capital Gains from when the stock is sold 6.4 The Present Value of Common Stocks • Is the value of a stock equal to: 1. The discounted present value of the sum of next period’s dividend plus next period’s stock price, or 2. The discounted present value of all future dividends? • The answer is actually both! • Are investors too shortsighted to care about the longrun stream of dividends? Then only near term dividends will be reflected. • But, long run dividend discount model holds even when investors have shortterm time horizons. • This is because even if investors want to cash out early, they must find another investor who is willing to buy. The price this second investor pays is dependent on dividends after the date of purchase. 6.4 The Present Value of Common Stocks Case 1: Zero Growth • Assume that dividends will remain at the same level forever • Since future cash flows are constant, the value of a zero growth stock is the present value of a perpetuity: r P r r r P Div ) 1 ( Div ) 1 ( Div ) 1 ( Div 3 3 2 2 1 1 = + + + + + + = = = = 3 2 1 Div Div Div P 0 = Div1 / r = 0.75/0.12 = $6.25 ABC Corp. is expected to pay $0.75 dividend per annum, starting a year from now, in perpetuity. If stocks of similar risk earn 12% annual return, what is the price of a share of ABC stock ?...
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This note was uploaded on 12/16/2011 for the course ACSTC 371 taught by Professor Lisaporth during the Fall '11 term at Waterloo.
 Fall '11
 LisaPorth

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