306 Chapter 8: Stock Valuation

Valuation of Stock

It is tough due to 3 reasons. 1) You don't know the promised cash flows in advance 2) life of the investment essentially lasts forever, there is no maturity date. 3) There is not way to easily observe the rate of return that the market requires.

Zero Growth Formula

P0=D/R

The price of stock is

is really just the present value of all expected future dividends!!

8.3

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One Period Example

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RR EXAMPLE

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Common Stock Features

1) Voting Rights: get to vote for the board 2) Proxy Rights 3) Classes of Stock 4) Other rights - The right to share proportional ing dividends paid - share proportional in remaining assets during liquidation - preemptive right, fist shot at new stick issue to maintain promotional ownership if desired. 5) Dividends - Dividends are not a liability of the firm until a dividend has been declared by the board - So... a firm cannot go bankrupt for not dealing dividends. - Dividends and taxes... ------not considered a business expense, so it is not tax deductible. ------ taxation of dividends received by individuals depends on the holding period. ------ Dividends received by corporation have a minimum 70% exclusion from taxable income.

Non constant Growth Model

1) calculate expected dividend 2) Calculate PV of the stock price the year it starts constant growth. (15% after year 2) --- if you have the expected dividend use the formula: P2= D3/(R-g) ------------------g= the constant growth rate ---- if you have don't have the expected dividend, use the formula P3=D3(1+g)/(R-g) 3) Find the PV of the expected future cash flow, do this for each year until you get to the constant growth year.

Shares of stock can receive cash in 2 ways:

1) company pays dividend 2) you can sell your shares of stocks to another investor or back to the company

Some special cases

1) dividend growth rate is zero 2) dividend growth at a constant rate 3) dividend grows at a constant rate after some length in time.

Dividend Yield

D1/Po A stocks expected cash dividend divided by it's current price.

Common Stock

Equity without priority for dividends or in bankruptcy

Equation for stock valuation

Po=(D1+P1)/(1+R) Po=the current rice of the stock P1=Price of the stock R= Required Return

Dividend Growth Model

Po=Do(1+g)/(R-g) =D1/(R-g)

Required Return

R=(Do(1+g)/Po)+g =D1/Po+g

Zero Growth

are dividends that are expected at regular intervals forever, then thesis a perpetuity and the present value of expected future dividends can be found using the perpetuity formula.

Constant growth (dividend growth model)

are dividends that are expected to grow at a constant percent per period.

Capital gains yield

g The dividend growth rate, or the rate at which the value of an investment grows.