Week 3 Project

Value of Stock

The value of a stock is nothing more than the time value of the future cash �ows. In the case of a stock, it is the discounted value of all the future dividends and other returns. The future returns of a stock are not as predictable as those of a bond. However, we still can use the concepts of TVM. The value of stock is the present value of all expected dividends plus the present value of the terminal value at the end of the life of the company. A preferred stock pays a constant dividend. The value of preferred stock is determined by treating it as perpetuity.

The value or price of a stock, assuming constant dividend growth (greater than the required rate of return), is determined by the Gordon growth model. This model, developed by Myron J. Gordon, is also known as the constant growth model. This would be similar to discounting the dividend payment into in�nity.

If you have uneven cash-�ow streams, a �nancial calculator and Microsoft Excel can help you to handle these problems without having to individually calculate each discounted cash �ow.

In the case where we are trying to double our funds, we can also use the rule of 72. The rule of 72 says that when the rate times the years is 72; you can use the ratio to determine the time to doubling. In other words, if we want the stock to double in 9 years, we need to earn a rate of return of 8%, or 72/9.