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Chapter

Section 8.1 -> Common Stock Valuation

by OneClass17300 , Fall 2011
3 Pages
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Department
Commerce
Course Code
COMMERCE 3FA3
Professor
T W Chamberlain

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Section 8.1
October 15, 2011
3:09 PM
Common Stock Valuation:
Hard to value because:
1. Not even the promise of cash flows are known in advance
1. Life of investment is essentially forever, no maturity
1. No way to easily observe the rate of return that the market requires
Common stock Cash Flows( CF)
Po= (D1- D2)/ (1+r)
Po= current price
D1= cash dividend paid at the end of the period
P1= price in one period
Over several periods:
Po = D1/ (1+r)1 + D2/ (1+r)2 + D3/ (1+r)3
Common Stock Valuation: Special Cases
Zero Growth:
A share of common stock in company with a constant dividend is much like a
share of preferred stock
D1 = D2 =D3=…
Per share value:
Po = D/r
r= required rate of return
D= cash flow
Constant Growth:
Stock with dividends that grows at a constant rate forever is an example of a
Growing Perpetuity
Dividend Growth model (A.k.a. Gordon Model)
Po = Do(1+g)/ (r-g) = D1/ (r-g) as long as g<r
Do= the dividend just paid
D1 = the next dividend to be paid
g= constant growth rate
Can use it to get the stock price at any point in time, not just present
Pt = Dt (1+g) / (r-g)
= Dt-1 / (r-g)

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Description
Section 8.1 October 15, 2011 3:09 PM Common Stock Valuation: Hard to value because: 1. Not even the promise of cash flows are known in advance 1. Life of investment is essentially forever, no maturity 1. No way to easily observe the rate of return that the market requires Common stock Cash Flows(CF) Po= (D1- D2)/ (1+r) Po= current price D1= cash dividend paid at the end of the period P1= price in one period Over several periods: P o D /1(1+r) + D / 21+r) + D / (3+r) … 3 Common Stock Valuation: Special Cases Zero Growth: A share of common stock in company with a constant dividend is much like a share of preferred stock D1 = D2 =D3=… Per share value: Po = D/r r= required rate of return D= cash flow Constant Growth: • Stock with dividends that grows at a constant rate forever is an example of a Growing Perpetuity • Dividend Growth model (A.k.a. Gordon Model) Po = Do(1+g)/ (r-g) = D1/ (r-g) as long as g
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