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ECON 4400

CHAPTER 8STOCK VALUATIONLearning ObjectivesLO1How stock prices depend on future dividendsand dividend growthLO2The characteristics of common and preferred stocksLO3The different ways corporate directors are elected to officeLO4The stock market quotations and the basics of stock market reportingAnswers to Concepts Review and Critical Thinking Questions1LO1 The value of any investment depends on its cash flows ie what investors will actually receive The cash flows from a share of stock are the dividends2LO1 Investors believe the company will eventually start paying dividends or be sold to another company3LO1 In general companies that need the cash will often forgo dividends since dividends are a cash expense Young growing companies with profitable investment opportunities are one example another example is a company in financial distress This question is examined in depth in a later chapter4LO1 The general method for valuing a share of stock is to find the present value of all expected future dividends The dividend growth model presented in the text is only valid i if dividends are expected to occur forever that is the stock provides dividends in perpetuity and ii if a constant growth rate of dividends occurs forever A violation of the first assumption might be a company that is expected to cease operations and dissolve itself some finite number of years from now The stock of such a company would be valued by the methods of this chapter by applying the general method of valuation A violation of the second assumpti
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