Stock Pricing - Salisbury University



Chapter 7 – Equity Markets and Stock Valuation

The price of any financial instrument is the present value of the future cash flows.

Preferred Stock

There is a 6 percent preferred share outstanding. If investors have a required return of 7 percent on this stock, what is the price?

P0 = [pic]

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Common stock

Assumption: The dividends grow at a constant rate forever. The following equation goes by many names. Here are a few:

Gordon Growth Model

Discounted Dividend Model

Dividend Model

[pic] = [pic]

Suppose a stock will pay a dividend of $2.50 next year and the dividends will grow at 6 percent forever. If the required return is 13 percent, what is the price per share today?

[pic]

Suppose a stock just paid a dividend of $1.80 and the dividends will grow at 6 percent indefinitely. If the required return is 11 percent, what is the current stock price?

[pic] = [pic]

What is the stock price in 8 years?

[pic] = [pic]

P8 = $38.16(1 + .06)8 = $60.82

What is the stock price in 15 years?

[pic] = [pic]

P15 = $38.16(1 + .06)15 = $91.45

Growing Perpetuities

You want to buy a song catalog. The royalties next year will be $1 million, and are expected to decrease by 8 percent per year indefinitely. If you want a 13 percent return, what is the most you should pay for the catalog?

[pic]

Where does g come from?

g = ROE × b

Required Return

We can solve the Gordon Growth Model for R, the required return.

[pic]

We are analyzing a stock with a current price of $25 per share. The current dividend (D0) is $1 per share and is expected to grow at 4.5 percent per year indefinitely. What is the required return for this stock?

[pic]

We will not cover the non-constant growth section.

Read Sections 7.2 and 7.3

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