After completing this unit, you should be able to: Understand how share prices depend on future dividends and dividend growth, be able to compute share prices using the dividend growth model, understand how share markets work, understand how share prices are quoted. | Chapter 7 Lecture - Equity Markets and Stock Valuation Chapter 7 Lecture Equity Markets and Stock Valuation Learning Objectives After studying this chapter, you should be able to: LO1 Understand how stock prices depend on future dividends and dividend growth LO2 Be able to compute stock prices using the dividend growth model LO3 Understand how corporate directors are elected LO4 Understand how stock markets work LO5 Understand how stock prices are quoted 7- 1 7- 2 The Stock Market Cash Flows for Stockholders Equity securities represent an ownership interest in a corporation. Holders of equity securities are entitled to the earnings of the corporation when those earning are distributed in the form of dividends; they are also entitled to a prorata share of the remaining equity in case of liquidation. If you own a share of stock, you can receive cash in two ways The company pays dividends You sell your shares, either to another investor in the market or back to the company As with bonds, the price of the stock is the present value of these expected cash flows Dividends → cash income Selling → capital gains 7- 3 7- 4 1 Chapter 7 Lecture - Equity Markets and Stock Valuation One Period Example One Period Example D1 = $2 dividend expected in one year R = 20% P1 = $14 CF1 = $2 + $14 = $16 Compute the PV of the expected cash flows Suppose you are thinking of purchasing the stock of Moore Oil, Inc. You expect it to pay a $2 dividend in one year You believe the dividend payment will increase 5% per year. You believe you can sell the stock for $14 at that time. You require a return of 20% on investments of this risk What is the maximum you would be willing to pay? P0 (2 14) $ 7- 5 7- 6 Two Period Example Three Period Example What if you decide to hold the stock for two years? We assume stock price at that time will grow by same rate as dividend. D1 = $ CF1 = $ D2 = $ CF2 = $ + $ = $ P2 = $ Now how much would
