Corporate Finance Lecture 5 (PDF)

SKEMA BUSINESS SCHOOL Lecture 5 Stock valuation Reading requirements Chapter 5.4–5.9 How to value stocks Corporate Finance, European edition, by Hillier, Ross, Westerfield, Jaffe and Jordan, McGraw-Hill ed., 4th. Get a...

SKEMA BUSINESS SCHOOL Lecture 5 Stock valuation Reading requirements Chapter 5.4–5.9 How to value stocks Corporate Finance, European edition, by Hillier, Ross, Westerfield, Jaffe and Jordan, McGraw-Hill ed., 4th. Get access to the book @ https://k2.skema.edu in the course Corporate Finance Outlines Absolute valuation - discounting cash flows (DCF) Relative valuation - multiples Income stocks versus growth stocks Stock valuation Several approaches to determine a stock's value Net Asset Value (NAV), Liquidation Value, Market Value Here we are concerned with MARKET VALUE Two alternative methods to estimate the market value The absolute valuation approach (DCF, DDM) The relative valuation approach (multiples)  Absolute valuation Discounting Cash Flows Absolute valuation – Discounting Cash Flows From what we saw in the session 2 on Net Present value, we can write: 𝑃1 + 𝐷𝑖𝑣 𝑃 = 1+𝑟 The price today P0 depends on discounted future cash flows dividends to be received Div future reselling price P1 all discounted at an expected (or required) rate r  Absolute valuation – Discounting Cash Flows Now, what if you are going to hold the stock forever The stock will never be resold You will receive an infinite series of cash flows as dividends Price of the stock = PV (expected future dividends) 𝐷𝑖𝑣𝑖 𝑃 = 𝑖 1+𝑟 𝑖=1 Absolute valuation – Discounting Cash Flows If a stock is to be held forever and if its dividends are constant, then 𝐷𝑖𝑣 𝐷𝑖𝑣 𝑃 = 𝑖 = 1+𝑟 𝑟 𝑖=1 Now what if dividend are not constant but grow at a rate g (g