1. Stock Valuation CHAPTER 5

2. What are we going to learn in this chapter?

3. Common Stock Valuation What does a share of stock represent? Which rights does an investor who buys a share of stock have?

4. Common Stock Valuation Why is it difficult to value a share of common stock?

5. Common Stock Valuation Imagine that you are considering buying a share of stock today. You plan to sell the stock in one year. You somehow know that the stock will be worth TL 70 at that time. You predict that the stock will also pay a TL 10 per share dividend at the end of the year. If you require a 25 percent return on your investment, what is the most you would pay for the stock? P0 = ?

6. Common Stock Valuation Let P 0 be the current price of the stock, and assign P 1 to be the price in one period. If D 1 is the cash dividend paid at the end of the period, then: Given a predicted dividend in two periods, D 2, the stock price in one period would be: If we substitute this expression for P 1 into our expression for P 0, we would have:

7. Common Stock Valuation Now we need to get a price in two periods: If we substitute this back in for P 2, we have:

8. Common Stock Valuation The current price of the stock can be written as the present value of the dividends beginning in one period and extending out forever: We have illustrated here that the price of the stock today is equal to………… How many future dividends to consider? How to handle?

9. Estimating Dividends: Special Cases Constant dividend (zero growth) Constant dividend growth Supernormal growth

10. Constant Dividends If dividends are expected to be constant (D t =D) at regular intervals forever, then value stock as a perpetuity: Suppose stock is expected to pay a TL 0.50 dividend every year and the required return is 2.5 % annually. What is the price?

11. Constant Growth Dividends are expected to grow at a constant percent per period. D1 = D2 = or D2 = D3 = or D3 = or D3 = …… And:

12. Constant Growth Thus we have: (growth rate has to be smaller than R) Example: Suppose Akçansa just paid a dividend of TL 0.50. It is expected to increase its dividend by 2% per year. If the market requires a return of 15% on assets of this risk, how much should the stock be selling for?

13. Constant Growth Suppose Kıran Holding is expected to pay a TL 2 dividend in three years(3 rd year). If the dividend is expected to grow at 5% per year after that and the required return is 20%, what is the price?

14. Non-Constant Growth Suppose a firm expects to increase dividends by 20% in one year and by 15% in two years. After that, dividends will increase at a rate of 5% per year indefinitely. If last year’s dividend was TL 1 and the required return is 20%, what is the price of the stock?

15. Components of Required Return We had: P0 = D1 / (R-g) If we rearrange this to solve for R, we get: This tells us that the total return, R, has two components:

16. Components of Required Return A firm’s stock is selling for TL 10.50. It just paid a TL 1 dividend and dividends are expected to grow at 5% per year. What is the required return? What is the dividend yield? What is the capital gains yield?

17. What About Stocks that Don’t Pay Dividends?

18. Problem Muhittin pays 2,000 TL for 100 shares. Is expected to receive 500 TL of dividends at the end of year 1. Is expected to receive 550 TL of dividends at the end of year 2. Is expected to sell stocks for 1,650 at the end of year 1. Interest rates expected to be 20 %. Is Muhittin smart?

19. Problem The firm has distributed dividends of TL 2.5 this year. Dividends have been growing at 15 % in the last 10 years. Expected to continue this growth. Investors require a rate of return of 20 %. What should the price be?

20. Problem The firm has distributed dividends of TL 2.5 this year. Dividends have been growing at 15 % in the last 10 years. Expected to continue this growth. Investors require a rate of return of 10 %. What should the price be?

21. Problem Dividends of this year 2 TL. 20 % growth for dividends in the following 5 years. Following the fifth year growth at 10 % forever. Required return rate is 10 %. PRICE of the stock?

22. END OF CHAPTER