Example 1 valuing common stock using a multiperiod ddm 1 of...

EXAMPLE 1: VALUING COMMON STOCK USING A MULTIPERIOD DDM (1 OF 2) You are considering investing in Bank of America's stock for a three year period. During the three year period you will have a stream of dividend payments. At the end of the third year you expect to sell the stock for $20. Given a 10% required rate of return, what is the value of Bank of America's common stock? 0 1 2 3 $1.00 $1.05 $1.10 $20.00

Transcript

00:03 So, here in a question, the question is in three parts.

00:07 So, at part a we have to determine the maximum price we would pay for a share.

00:13 So, for this we need to calculate the present value of future dividends and present value of selling price.

00:21 So, let's calculate present value of dividends.

00:29 So, what is the formula for this? it is equals to d 1 divided by 1 plus r plus d 2 divided by 1 plus r to the power 2.

00:44 Here d 1 expected the first year dividend, d 2 is second year dividend, r is rate of return.

00:52 So, let's put the values here.

00:54 When we put the values, we got 2 .0 divided by 1 plus 0 .12 as given in a question.

01:04 D values plus 2 .25 divided by 1 plus 0 .12 to the power 2.

01:14 When we solve it or when we calculate it, we got the value which is equals to 3 .57940051.

01:29 So, this is our present value for dividends.

01:32 Now, let's move towards the next thing that is present value of selling price, present value of selling price.

01:42 So, what the formula we can use here? the sp that is selling price divided by 1 plus r to the power 2, where sp is a selling price and r is a rate of interest.

01:58 So, let's put the values according to the question.

02:01 17 .50 divided by 1 plus 0 .12 to the power 2.

02:09 When we calculate it or solve it, we got the value 13 .950 08929.

02:18 So, this is our pv that is present value of selling price.

02:22 Now, finally, we have to get the maximum price what ask in the question in part a.

02:28 So, the maximum price how we can calculate this is equals to present value of dividends plus present value of selling price.

02:42 So, we have the both of these.

02:44 Let's put the values together.

02:46 So, we got 3 .57940051 plus 13 .9508929.

03:10 So, when approximately we calculate it, we got here 19 .42 approx.

03:25 This is our approx value.

03:27 We can say let's put it together.