Ch 8- Stocks Class Notes

Question 1

What are stocks

Answer 1

another way to finance a company that is not bonds (short term loans)

Question 2

when you buy stocks you can get cash in 2 ways

Answer 2

1. companies may pay dividends
   - not very many companies pay dividends in canada, just 10%
2. sell ur stocks

Question 3

What does listed mean?

Answer 3

You can buy and sell shares on an exchange such as the TSX without the company’s permission

listed: company has put shares into the market and given up control on who can own the shares

Question 4

How to do stock questions- max willingness to pay

Answer 4

1. Create a timeline, and see how much of a return you get in one year (dividend price) and year two (sale + dividend price)…
2. Divide this by (1+rate of return) for year 1 and (1.##)^2 for the year 2

where 1+rate of return is the rate of % you want

this is just discounting cash flows

Question 5

price of the stock is the present value of ALL expected future dividends + ONE sale (You can only sell this once)

Question 6

When you are estimating dividends, what is the formula

Answer 6

P= C/r its the same formula as pertuity

the dividends will stay constant

Cash flow/interest rate

Question 7

What is constant dividend growth, and the gordon grwoth model

Answer 7

the firm will increase the dividend by a constant percent per period

P0= D0(1+g)/R-g = D1/R-g

P0= Price stock is currently selling for
R= required return
g= growth rate
D0= Dividend year 0 (DIVIDEND THAT WAS JUST PAID)
D1- Dividend year 2 (DIVIDEND WE EXPECT TO GET IN THE UPCOMING YEAR, MAYBE @ YE) (stock PAYSSS a dividend) (IS EXPECTED TO PAY)

Question 8

What is supernormal growth

Question 9

What is zero growth

Answer 9

dividends are expected at reular intervals for ever, its like preferredd stock and valued as a perpetuity

the stocks return is ONLY frm its dividend

Po= D/r = dividend/ required return

Question 10

formula to calculate the yield

Answer 10

THIS FORMULA CAN BE USED WHEN THERE IS A CONSTANT GROWTH RATE, IF THERE IS A CHANGING DIVIDEND GROWTH RATE THEN WE CANT USE THIS FORMULA

D1/P0= Dividend in the future year/ Price stock is currently selling for

when this formula can be used: r= Yield + growth

Question 11

What is the sensitivity in the constant dividend growth rate formula?

Answer 11

If growth increases, then the stock price increases as well

1:1 ratio

Question 12

How to use the gordon growth model for a year multiple years in the future

Answer 12

P4= D4(1+g)/r-g = D5/r-g

(we just expanded the initial formula) and adjusted the numbers

now we have to include the period increase

P4= (D4(1+g)^n )/r-g

Put the 1+growth rate ^ n number of periods in the future (4 for 4 years in the future)

Question 13

in constant dividend growth…

Answer 13

the price grows at the same rate as the dividends

AND THIS MAKES SENSE!! AS THE PRICE OF THE STOCK GOES UP THEN DIVIDENDS SHOULD GO UP 1-1

Question 14

What is nonconstant dividend growth?

Answer 14

when a firms dividends grow in a non-linear way

DO NOT FOLLOW THE GORDON GROWTH MODEL

Question 15

How to do nonconstant dividend growth rate questions?

Answer 15

1. draw a timeline, time 0 is the starting point
2. to get year 1 dividend value, multiply year 0 dividend by year 1’s dividend rate
   D1= og x 1.##A
3. Use the answer for D1 to replace the og and multiply by the Next years given rate
   D2= D1 x 1.##B
4. Continue
   D3= D2 x 1.##C
5. find the expected year price:
   -think of yourself as standing at the year 2
   - the next year in YOUR PERSPECTIVE is the NEW year 1
   - Use the last calculated value you found (Df) in this formuls

Df/r-g

YOU CAN USE THE GORDON GROWTH MODEL AT THE VERY END HERE

6. To find the present value of the expected future cash flows, discount all of the Ds you calculated by the growth rate

P0=( D1/1+g )+ D2 + P2 / (1+g)^2

-MAKE SURE YOU DO THIS PROPERLY!! FOR YEAR 1 divide it regularly, for YEAR 2 ^2