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Essentials of Corporate Finance 9th Edition Ross Solutions Manual 1
Essentials of Corporate Finance 9th Edition Ross Solutions Manual 1
Chapter 7
EQUITY MARKETS AND STOCK VALUATION
Copyright (c) 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
7-1
Chapter 07 – Equity Markets and Stock Valuation
Copyright (c) 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
7-2
Chapter 07 – Equity Markets and Stock Valuation
CHAPTER WEBSITES
Websites may be referenced more than once in a chapter. This table just includes the
section for the first reference.
Cash flows are discounted at the required return, R, which, in equilibrium, is the same
as the “expected return.”
Copyright (c) 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
7-3
Chapter 07 – Equity Markets and Stock Valuation
Slide 7.6 Note that the period 1 cash flow includes both the dividend AND the
selling price. Also, stress that the dividend given in the problem is the EXPECTED
dividend at time t = 1.
Lecture Tip: As the text points out, a stock that currently pays no dividends may or
may not have value; a stock that will NEVER pay a dividend cannot have any value
as long as investors are rational. For a stock that currently pays no dividend, market
value derives from (1) the hope of future dividends and/or (2) the expectation of a
liquidating dividend. In the latter case, “never pays a dividend” really means “never
pays out cash in any form” to shareholders. Students will often argue strenuously
that a firm never has to pay a dividend because investors can just rely on the increase
in price.
Emphasize that the price won’t continue to increase forever. The company will
eventually run out of productive ways to use its cash. When this happens, it will need
to begin paying dividends.
Another way to think of this is that a company that never pays a dividend, including a
liquidating dividend, is essentially a perpetual zero coupon bond. It is a black hole
where you put money in but you never get anything back out.
investment opportunities for its earnings. On May 31, 2002, FedEx’s Board of
Directors declared its first quarterly dividend of $0.05 per share. This was a
milestone decision for the company because dividends are considered “sticky,”
meaning once a firm starts paying dividends, its shareholders expect them to continue
and for the dividend to grow.
Because the cash flow is always the same, the PV is that for a perpetuity:
P0 = D / R
Example (on slide): Suppose a stock is expected to pay a $0.50 dividend each
quarter forever, and the required return is 10% compounded quarterly.
Remind students that if dividends are paid quarterly, then the discount rate must
be a quarterly rate.
The slide shows the dividends stream for a constant growth stock.
Lecture Tip: Emphasize the difference between the dividend just paid (D0) and the
expected dividends (D1 to Dt). The “just paid” dividend is only used to estimate future
dividends. It is NOT used in the PV calculation in any other way, because we are
concerned with future cash flows, not past ones.
Copyright (c) 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
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