note13-425 - CHAPTER 13. EQUITY VALUATION CHAPTER 13....

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CHAPTER 13. EQUITY VALUATION CHAPTER 13. EQUITY VALUATION Basic Definitions: Book Value is the net worth of a company as reported on its balance sheet. Current market price of stocks of companies can sell below their book value. The liquidation value per share is the net amount that can be realized by selling the assets of a firm and paying off the debt. Replacement cost is the cost to replace a firm’s assets. Intrinsic Value vs Market Price Intrinsic value is the present value of a firm`s expected future net cash flows discounted by the required rate of return. Expected Holding Period Return (HPR) = E(r) = ( 29 ( 29 [ ] 0 0 1 1 P P P E D E - + Where E (D 1 ) = expected dividend per share E (P 1 ) = expected price of a share at the end of period P 0 = current price of a share Intrinsic Value using a one year investment horizon: ( 29 ( 29 k P E D E V + + = 1 1 1 0 Where V 0 = intrinsic value r = required rate of return
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CHAPTER 13. EQUITY VALUATION Example: ABC Stock Expected dividend per share during a year = 4$ Current price = 48$ Expected price at the end of the year = 52$ Expected HPR = ( 29 % 7 . 16 48 48 52 4 = - + Required rate of return(expected) = k, CAPM k = r f + β [ E(r M ) – r f ] where r f = return on risk free asset (risk free rate) r m = expected rate of return in the market portfolio β = risk level of the security rf = 6% rm = 11% β = 1.2 k = 6% + 1.2 x 5% = 12% Intrinsic Value = V 0 = $ 50 12 . 0 1 $ 52 $ 4 = + + for a one year investment horizon Concept check 13.1 in page 405. Dividend Discount Models According to the DDM, V 0 = ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 N N N k P E D E k P E D E k P E D E + + + + + + + + 1 ....... 1
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note13-425 - CHAPTER 13. EQUITY VALUATION CHAPTER 13....

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