Chapter 8 Stock Valuation

Question 1

What are the three reasons that evaluating stocks is harder than bonds?

Answer 1

1. There is no known promised cash flows
2. The life of the investment has no maturity
3. There is no way to easily observe the rate of return that the market requires

Question 2

What is the equation for the Current Price of the stock?

Answer 2

Po = D1 / (1+r)^1 + D2 / (1+r)^2 + P2 / (1+r)^2

Question 3

What are the dividends for a Zero Growth Common Stock?

Answer 3

D1 = D2 = Constant

Po = D / r

Question 4

What is the equation for constant growth Dividend

Answer 4

Dt = D0 * (1+g)^t

Question 5

What does it mean when the constant growth rate exceeds the discount rate? (g > r)

Answer 5

The stock price is infinitely large.

When the growth rate is bigger than the discount rate the PV of the dividends keeps on getting bigger and bigger.

Question 6

What is the equation for the PV of a constant growth stock

Answer 6

P0 = [Dt * (1+g)^t] / r-g

When r > g