NC8 - Why does the value of a share of stock depend on...

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Why does the value of a share of stock depend on dividends? The value of all investments depend on The Present Value of the Expected Future Cash Flows One source of cash flows from a share of stock is the dividends. A substantial percentage of the companies listed on the NYSE and NASDAQ don’t pay dividends, but investors are nonetheless willing to buy shares in them. How is this possible given your answer to the previous question? Investors believe the company will eventually start paying dividends (or be sold to another company). If investors are rational, they must believe there are expected future cash flows from the investment. Referring to the previous questions, under what circumstances might a company choose not to pay dividends? In general, companies that need the cash will often forgo dividends since dividends are a cash expense. Young, growing companies with profitable investment opportunities are one example; another example is a company in financial distress. As an investor, do you want the company you own to pay dividends? As a CFO, how would you decide whether to pay a dividend? The Jackson-Timberlake Wardrobe Co. just paid a dividend of \$1.95 per share on its stock. The dividends are expected to grow at a constant rate of 6 percent per year indefinitely. If investors require an 11 percent return on the Jackson-Timberlake Wardrobe Co. stock, what is the current price? What will the price be in 3 years? In 15? The constant dividend growth model is: P t = D t × (1 + g ) / ( R g ) P t = D t+1 / ( R g ) So the price of the stock today is: P 0 = D 0 (1 + g ) / ( R g ) = \$1.95 (1.06) / (.11 – .06) = \$41.34 To get the price at year 3, you need the expected dividend at year 4. The dividend at year 4 is the dividend today times the FVIF for the growth rate in

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This note was uploaded on 02/16/2012 for the course FINANCE 301 taught by Professor Bean during the Spring '11 term at Drexel.

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NC8 - Why does the value of a share of stock depend on...

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