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09 Chapter model
12/12/08
Chapter 9.
Stocks and Their Valuation
THE DISCOUNTED DIVIDEND MODEL (Section 94)
The basic dividend valuation equation is:
+
+
.
.
.
.
EXAMPLE
$1.15
g
8.3%
13.7%
=
=
$1.25
0.054
$23.06
STOCK PRICE SENSITIVITY
Resulting
% Change
Last
Price
$23.06
30%
$0.81
$16.14
15%
$0.98
$19.60
0%
$1.15
$23.06
15%
$1.32
$26.52
30%
$1.50
$29.98
% Change
$23.06
30%
9.38%
$115.32
15%
11.39%
$40.31
0%
13.40%
$24.42
15%
15.41%
$17.52
30%
17.42%
$13.66
% Change
g
$23.06
30%
5.60%
$14.99
15%
6.80%
$17.80
0%
8.00%
$21.79
15%
9.20%
$27.91
30%
10.40%
$38.47
+
g
EXAMPLE
$23.06
$1.245
g
8.3%
13.70%
Div Yield
=
5.40%
Capital Gains Yield
=
8.30%
EXTENSION
What is the expected price of this stock in 5 years?
N
=
5
Using the growth rate we find that:
$34.36
Figure 94.
Nonconstant Growth Stocks (Section 96)
EXAMPLE
$1.15
13.4%
30%
Shortrun g; for Years 13 only.
8%
Longrun g; for Year 4 and al fol owing years.
<    
30%
     >
8%
Year
0
1
2
3
4
Dividend
$1.15
1.495
1.9435
2.5266
2.7287
PV of dividends
$1.32
1.51
1.73
2.7287
$4.56
50.5310
=
Terminal value
=
34.65
0.054
$39.21
EXAMPLE
/
$10.00
/
10.30%
$97.09
EXAMPLE
N
50
I/YR
10%
PMT
$10
FV = Par value
$100
Price
$100.00
What would its value be if the required return declined to 8%?
N
50
I
8%
PMT
$10
Face value
$100
Price
$124.47
Had this been a perpetual preferred, the new stock price would have been:
Price
$125.00
This model is similar to the bond valuation models developed in Chapter 7 in that we employ
discounted cash flow analysis to find the value of a firm's stock.
COMMON STOCK VALUATION
(Section 94)
The value of any financial asset is equal to the present value of future cash flows provided by the
asset.
Stocks can be evaluated in two ways:
(1) by finding the present value of the expected
future dividends, or (2) by finding the present value of the firm's expected future free cash flows,
subtracting the value of the debt and preferred stock to find the total value of the common equity,
and then dividing that total value by the number of shares outstanding to find the value per share.
Both approaches are examined in this spreadsheet.
When an investor buys a share of stock, he/she typical y expects to receive cash in the form of
dividends and then, eventual y, to sel the stock and to receive cash from the sale.
Moreover, the
price any investor receives is dependent upon the dividends the next investor expects to earn,
and so on for dif erent generations of investors.
P
0
=
D
1
D
2
D
n
( 1 + r
s
)
( 1 + r
s
)
2
( 1 + r
s
)
n
The dividend stream theoretical y extends on out forever, i.e., n = infinity.
It would not be feasible
to deal with an infinite stream of dividends, but if dividends are expected to grow at a constant
rate, we can use the constant growth equation as developed in the text to find the value.
CONSTANT GROWTH STOCKS (Section 95)
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This note was uploaded on 01/11/2012 for the course FIN 3403 taught by Professor Tapley during the Fall '06 term at University of Florida.
 Fall '06
 Tapley
 Finance, Stock Valuation, Valuation

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