The price of the common stock
Concept Introduction:
The Common stock is the security which is issued by corporations to raise capital. Usually, people who purchase such securities are called stockholder. They are paid a dividend as income
Explanation of Solution
There are various models to determine the price of a common stock. These are as follows:
- The one-period valuation Model
- The Generalized Dividend Valuation Model Under this model, the price of a stock is calculated for n-number of periods. The value of a stock today is the present value of the future cash flows. The only cash flow is a dividend and a final sales price when the stock is ultimately sold after n-period.
- The Gorden-Growth Model
Under this model, the price of the stock is calculated only for a year period, i.e., an investor keeps a stock only for a year period.
To value the stock today, the present discounted value of the expected cash flow(future payment) is calculated. The cash flow consists of dividend payment and sale price.
where
D1= dividend given by the corporation at the end of the year
P0= Current value of the stock P1= the expected sales price of the stock
Ke= The required return on equity
where
Dn= dividend given by the corporation at the end of n periods
P0= current price of a stock
Pn= Price of stock after n-periods
Ke= the required return on equity
This model estimated the price of the stock when corporations strive to give regular dividend at regular interval of time.
D0=the most recent dividend paid
G= the expected constant growth rate in dividends
Ke=the required
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