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Chapter

Section 8.1 -> Common Stock Valuation

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Department
Commerce
Course
COMMERCE 3FA3
Professor
T W Chamberlain
Semester
Fall

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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