Valuation and Characteristics of Common Stocks


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Unformatted text preview: y have the last claim on the assets of the firm after paying off creditors and bond holders and preferred stockholders They are also residual owners How to value common stock? How to value common stock? PV of expected cash flows for common stockholders when discounted at the required rate of return for the common stockholders What cash flows are expected by common stockholders? An unequal stream of dividends for each year Value of Common Stock = PV of dividends for common stock holders Simplifying Assumptions to Value Common Stock Zero Growth Model Constant Growth Model Zero Growth Model Zero Growth Model If we assume that dividend for common stockholder will be the same every year DIV1 = DIV2 =DIV3=……=DIV∞ Under zero growth model, stockholders anticipate to receive the same amount of dividend per year forever Thus, we have a perpetuity of dividends Price of Stock will equal the present value of this perpetuity Examples Constant Growth Model Constant Growth Model If we assume that dividends grow at a constant rate of ‘g’ per year forever DPS1 P0 = ­­­­­­­­­ r ­ g...
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