If you have a share of stock, you can receive cash
in two ways:
1. The company pays dividends.
2. You sell your shares, either to another investor
in the market or back to the company.
As with bond price of stock is the PV (present
value) of these expected cash flows.
Stock is more difficult to value in practice than
Not even the promised cash flows are known
Life of investment is forever (no maturity).
No way to easily observe the rate of return that
P0= (D1 + P1)
P1= (D2 + P2)
• Constant dividends (zero growth):
- The firm will pay constant dividends forever.
- This is like preferred stock.
- Price is computed using perpetuity formula:
r • Constant dividend growth:
- The firm will increase the dividend by a
constant % every period.
• Supernormal growth: