Stock Valuation Chapter 9

Chapter 9
Stock V l ti St k Valuation

McGraw-Hill/Irwin

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Key Concepts and Skills
Understand h stock prices depend on future U d d how k i d d f dividends and dividend growth  B able to compute stock prices using the Be bl k i i h dividend growth model U d Understand h growth opportunities affect d how h ii ff stock values U d Understand valuation comparables d l i bl  Understand how stock markets work

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Chapter Outline
9.1 91 9.2 9.3 9.4 94 9.5 9.6 The P Th Present Value of C V l f Common S k Stocks Estimates of Parameters in the Dividend Discount Model Growth Opportunities Comparables Valuing the Entire Firm The Stock Markets

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9.1 The PV of Common Stocks
 

The value of any asset is the present value of its expected future cash flows. Stock S k ownership produces cash fl hi d h flows from: f
 

Dividends Capital Gains Zero Growth Constant Growth Differential Growth e e t a G owt
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

Valuation of Different Types of Stocks
  

Case 1: Zero Growth


Assume that di id d will remain at the same level A h dividends ill i h l l forever

Div 1  Div 2  Div 3  

 Since future cash flows are constant, the value of a zero

growth stock is the present value of a perpetuity:

Div 3 Div 1 Div 2 P0     1 2 3 (1  R) (1  R) (1  R) Div P0  R
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Case 2: Constant Growth
Assume that dividends will grow at a constant rate, g, h di id d ill forever, i.e.,

Div 1  Div 0 (1  g )

Div 2  Div 1 (1  g )  Div 0 (1  g ) 2 Div 3  Div 2 (1  g )  Div 0 (1  g ) 3
. . .

Since future cash flows grow at a constant rate forever, the value of a constant growth stock is the present value of a growing perpetuity:

Div Di 1 P0  Rg

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Constant Growth Example
Suppose Big D, Inc., just paid a dividend of $.50. It is expected to increase its dividend by 2% per year. If the market requires a return of 15% on assets