Chapter 18 Equity Valuation Models - Business.UNL.EDU

[Pages:27]Chapter 18 Equity Valuation Models

Models of Equity Valuation

? Balance Sheet Models

? Book Value

? Dividend Discount Models ? Price/Earning Ratios

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Intrinsic Value and Market Price

? Intrinsic Value ? Self assigned Value ? Variety of models are used for estimation

? Market Price (MP) ? Consensus value of all potential traders

? Trading Signal ? IV > MP Buy ? IV < MP Sell or Short Sell ? IV = MP Hold or Fairly Priced

3

Dividend Discount Models: General Model

0 =

1 +

=1

V0 = Value of Stock Dt = Dividend k = required return

4

No Growth Model

0

=

1

The no growth model would work for common stocks that have earnings and dividends that are expected to remain constant (this assumption is probably not too realistic).

A good example of a claim that has constant dividends is Preferred Stock

5

No Growth Model: Example

0

=

1

D1 = $5.00 k = 0.15 V0 = $5.00 / 0.15 = $33.33

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The constant growth model

0 =

0 1 + (1 + )

=1

Where

D1 = D0(1+g) D2 = D1(1+g) = D0(1+g)2 and so on .....

As long as k > g, the sum will converge to:

0

=

0(1 + ) -

=

1 -

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Constant Growth Model: Example

0

=

0(1 + ) -

=

1 -

k = 15% D1 = $3.00 g = 8% (therefore: D0 = 3/1.08) V0 = 3.00 / (0.15 - 0.08) = $42.86

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