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Unit 3 Notes: Valuing Stocks and Bonds

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Corporate Finance lecture notes for the EMBA at UNSW.

Stocks and BondsFinancial mathematics
P0 = Price of stock at time = 0A∞= Present value of perpetuity
d = Dividend cash flowR = Regular cash flow
re  = Required return on equityr = Rate of return

 

Valuing constant dividends
P = \frac{{{\rm d}}_{{\rm 1}}}{{{\rm r}}_{{\rm e}}} is the same formula as perpetuity constant growth rate A{}_{\infty } = \frac{{\rm R}}{{\rm r}}

Valuing constant growth rate
P${}_{0}$ = $\frac{{{\rm d}}_{{\rm 1}}}{{{\rm (r}}_{{\rm e}}{\rm -\ g)}}$ is the same formula as perpetuity A${}_{\infty }${}_{,g}$ = $\frac{{{\rm R}}{{\rm 1}}}{{\rm (r-g)}}$
g can be +ve or –ve growth

Rough estimate of ‘g’
Growth occurs by re investing profits into profitable project.
Disadvantage: there are other ways company can growth without reinvesting back into project. E.g. Enter new market.

g = Plowback ratio x Return on Equity
= (1 - Dividend\ payout\ ratio)$ x RoE
= (1 - \frac{{\rm Dividends\ per\ share}}{{\rm Earnings\ per\ share}}$) x RoE
= (1 - \frac{{{\rm d}}_{{\rm 1}}}{{\rm Earnings\ per\ share}}{\rm )}$ x RoE

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