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1、Chapter 8 Stock Valuation McGraw Hill Irwin Copyright 2013 by The McGraw Hill Companies Inc All rights reserved Key Concepts and Skills Understand how stock prices depend on future dividends and dividend growth Be able to compute stock prices using the dividend growth model Understand how corporate
2、directors are elected Understand how stock markets work Understand how stock prices are quoted 8 2 Chapter Outline Common Stock Valuation Some Features of Common and Preferred Stocks The Stock Markets 8 3 Cash Flows for Stockholders If you buy a share of stock you can receive cash in two ways The co
3、mpany pays dividends You sell your shares either to another investor in the market or back to the company As with bonds the price of the stock is the present value of these expected cash flows 8 4 One Period Example Suppose you are thinking of purchasing the stock of Moore Oil Inc You expect it to p
4、ay a 2 dividend in one year and you believe that you can sell the stock for 14 at that time If you require a return of 20 on investments of this risk what is the maximum you would be willing to pay Compute the PV of the expected cash flows Price 14 2 1 2 13 33 Or FV 16 I Y 20 N 1 CPT PV 13 33 8 5 Tw
5、o Period Example Now what if you decide to hold the stock for two years In addition to the dividend in one year you expect a dividend of 2 10 in two years and a stock price of 14 70 at the end of year 2 Now how much would you be willing to pay PV 2 1 2 2 10 14 70 1 2 2 13 33 8 6 Three Period Example
6、 Finally what if you decide to hold the stock for three years In addition to the dividends at the end of years 1 and 2 you expect to receive a dividend of 2 205 at the end of year 3 and the stock price is expected to be 15 435 Now how much would you be willing to pay PV 2 1 2 2 10 1 2 2 2 205 15 435
7、 1 2 3 13 33 8 7 Developing The Model You could continue to push back the year in which you will sell the stock You would find that the price of the stock is really just the present value of all expected future dividends So how can we estimate all future dividend payments 8 8 Estimating Dividends Sp
8、ecial Cases Constant dividend The firm will pay a constant dividend forever This is like preferred stock The price is computed using the perpetuity formula Constant dividend growth The firm will increase the dividend by a constant percent every period The price is computed using the growing perpetui
9、ty model Supernormal growth Dividend growth is not consistent initially but settles down to constant growth eventually The price is computed using a multistage model 8 9 Zero Growth If dividends are expected at regular intervals forever then this is a perpetuity and the present value of expected fut
10、ure dividends can be found using the perpetuity formula P0 D R Suppose stock is expected to pay a 0 50 dividend every quarter and the required return is 10 with quarterly compounding What is the price P0 50 1 4 20 8 10 Dividend Growth Model Dividends are expected to grow at a constant percent per pe
11、riod P0 D1 1 R D2 1 R 2 D3 1 R 3 P0 D0 1 g 1 R D0 1 g 2 1 R 2 D0 1 g 3 1 R 3 With a little algebra and some series work this reduces to 8 11 DGM Example 1 Suppose Big D Inc just paid a dividend of 0 50 per share It is expected to increase its dividend by 2 per year If the market requires a return of
12、 15 on assets of this risk how much should the stock be selling for P0 50 1 02 15 02 3 92 8 12 DGM Example 2 Suppose TB Pirates Inc is expected to pay a 2 dividend in one year If the dividend is expected to grow at 5 per year and the required return is 20 what is the price P0 2 2 05 13 33 Why isn t
13、the 2 in the numerator multiplied by 1 05 in this example 8 13 Stock Price Sensitivity to Dividend Growth g D1 2 R 20 8 14 Stock Price Sensitivity to Required Return R D1 2 g 5 8 15 Example 8 3 Gordon Growth Company I Gordon Growth Company is expected to pay a dividend of 4 next period and dividends
14、 are expected to grow at 6 per year The required return is 16 What is the current price P0 4 16 06 40 Remember that we already have the dividend expected next year so we don t multiply the dividend by 1 g 8 16 Example 8 3 Gordon Growth Company II What is the price expected to be in year 4 P4 D4 1 g
15、R g D5 R g P4 4 1 06 4 16 06 50 50 What is the implied return given the change in price during the four year period 50 50 40 1 return 4 return 6 PV 40 FV 50 50 N 4 CPT I Y 6 The price is assumed to grow at the same rate as the dividends 8 17 Nonconstant Growth Example I Suppose a firm is expected to
16、 increase dividends by 20 in one year and by 15 in two years After that dividends will increase at a rate of 5 per year indefinitely If the last dividend was 1 and the required return is 20 what is the price of the stock Remember that we have to find the PV of all expected future dividends 8 18 Nonconstant Growth Example II Compute the dividends until growth levels off D1 1 1 2 1 20 D2 1 20 1 15 1 38 D3 1 38 1 05 1 449 Find the expected future price P2 D3 R g 1 449 2 05 9 66 Find the present val
