How can one calculate the present value of a stock given forecasts of future dividends and future stock price?

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How can one calculate the present value of a stock given forecasts of future dividends and future stock price?



Answer: Shareholders generally expect to receive (1) cash DIVIDENDS and (2) capital gains or losses. The rate of return that they expect over the next year is defined as the expected dividend per share DIV1 plus the expected increase in price P1-P0, all dividend by the price at the start of year P0.
Unlike the fixed interest payments that the firm promises to bondholders, the dividends paid to shareholders depend on the fortunes of the firm. That's why a company's common stock is riskier than its debt. The return that investors expect on any one stock is also the return that they demand on all stocks subject to the same degree of risk. The present value of a stock equals the present value of the forecast future return as the discount rate.
The present value of a share is equal to the stream of expected dividends per share up to some horizon date plus the expected price at this date, all discounted at the return that investors require. If the horizon date is far away, we simply say that stock price equals the present value of all future dividends per share. This is the DIVIDEND DISCOUNT MODEL.

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