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Causal Valuation Factors

discount. There is no impact on the current common stock price because those dividends are expected so far in the future.

The required rate of return must be increased beyond the long-term U.S. Treasury Bond yield to include the risk that expected dividends might not be received. The required rate of return (r) is the discount rate used to calculate the present value of the expected dividends. The required rate of return reflects all risks associated with common share ownership. The expanded required rate of return for individual common stock is developed throughout subsequent chapters to include the major categories of risk that must be considered.

THE CURRENT COMMON STOCK PRICE

The current common stock price (P) is the present value of the market consensus, expected dividends discounted to the present value by the required rate of return.

This concept is captured in Equation (3):

P = E_t ₌ ₁, „ E_t(1 - A) / (1 + r)^t (3)

where the symbols in Equation (3) stand for

P = current share price of the common stock

£_t=1, „ = the sum of the future from now to infinity

E_t = the expected future earnings in each future year t

A = the percentage of the earnings (E) retained. Thus 1 -

A is the payout rate. The numerator of the Equation (3) valuation framework is the expected dividend in each year t. Since A is assumed stable, it drops it from the equation to focus on earnings, the source of dividends.

r = the required rate of return used to discount the future

expected earnings, implying dividends, to the common share price (present value).

THE COMBINATIONS OF TABLE 1.1

The interacting factors of the Table 1.1 combinations are evident in the Equation (3) valuation framework. The numerator of the Equation (3) valuation framework is the expected $Benefits of Table 1.1,



	Causal Valuation Factors	11

	discount. There is no impact on the current common stock price because those dividends are expected so far in the future. The required rate of return must be increased beyond the long-term U.S. Treasury Bond yield to include the risk that expected dividends might not be received. The required rate of return (r) is the discount rate used to calculate the present value of the expected dividends. The required rate of return reflects all risks associated with common share ownership. The expanded required rate of return for individual common stock is developed throughout subsequent chapters to include the major categories of risk that must be considered.

	THE CURRENT COMMON STOCK PRICE The current common stock price (P) is the present value of the market consensus, expected dividends discounted to the present value by the required rate of return. This concept is captured in Equation (3): P = E_t ₌ ₁, „ E_t(1 - A) / (1 + r)^t (3) where the symbols in Equation (3) stand for P = current share price of the common stock £_t=1, „ = the sum of the future from now to infinity E_t = the expected future earnings in each future year t A = the percentage of the earnings (E) retained. Thus 1 - A is the payout rate. The numerator of the Equation (3) valuation framework is the expected dividend in each year t. Since A is assumed stable, it drops it from the equation to focus on earnings, the source of dividends. r = the required rate of return used to discount the future expected earnings, implying dividends, to the common share price (present value). THE COMBINATIONS OF TABLE 1.1 The interacting factors of the Table 1.1 combinations are evident in the Equation (3) valuation framework. The numerator of the Equation (3) valuation framework is the expected $Benefits of Table 1.1,