FNCE10001 Chapter Notes - Chapter 9: Discounted Cash Flow, Dividend Yield, Capital Gain
25 May 2018
School
Department
Course
Professor
Method to value a stock
Pay out cash in the form of a dividend
1.
Generate cash by selling the shares in the future
2.
2 potential sources of cash flows from owning a stock:
Total amount received depends on investment horizon
Investor is willing to buy the stock as long as NPV > 0 (current price < present value of expected
future dividend and sale price)
Discount cash flows based on equity cost of capital (r
E
)
r
E
= expected return of other investments available in the market with equivalent risk for the firm's
shares
P
0
= (Div
1
+ P
1
)/(1 + r
E
)
% return investor expects to earn from the dividend paid
-
Dividend yield = expected annual dividend of the stock divided by current price = Div
1
/ P
0
Capital gain = difference between expected sale price and purchase price
Capital gain rate = capital gain divided by current stock price = (P
1
-
P
0
)/P
0
Total return = dividend yield + capital gain = expected return investor will earn for a one
-
year
investment
Expected total return = expected return of other investments available in the market with equivalent
risk
General dividend
-
discount model for stock price
P
0
= Sum n=1
-
> infinity (Div
n
/(1 + r
E
)^n)
Dividend
-
Discount model
Thursday, 23 March 2017 2:34 PM
Principles of Finance Page 1
Document Summary
2 potential sources of cash flows from owning a stock: Pay out cash in the form of a dividend. Generate cash by selling the shares in the future. Investor is willing to buy the stock as long as npv > 0 (current price < present value of expected future dividend and sale price) Discount cash flows based on equity cost of capital (re) re = expected return of other investments available in the market with equivalent risk for the firm"s shares. Dividend yield = expected annual dividend of the stock divided by current price = div1 / p0. % return investor expects to earn from the dividend paid. Capital gain = difference between expected sale price and purchase price. Capital gain rate = capital gain divided by current stock price = (p1 - p0)/p0. Total return = dividend yield + capital gain = expected return investor will earn for a one-year investment.
