In this episode of MBA Insights, we delve into the core principles of financial asset pricing, with a special focus on stock valuation and investment project evaluation.

Starting with the basics, we explore competitive markets, arbitrage, and the Law of One Price. You'll learn how the absence of arbitrage opportunities in efficient markets shapes asset prices, illustrated through no-arbitrage pricing examples involving bonds and risk-free interest rates. We then introduce the separation principle, explaining why financial transactions in normal markets don’t inherently add value, unlike real investment projects that can drive true value creation.

Shifting to stock valuation, we break down the dividend discount model, which values stocks based on the present value of future dividends. We cover Gordon’s model for stable-growth scenarios, showing how to estimate the dividend growth rate (g) and handle scenarios where g is variable. Recognizing the model’s limitations, we then look at valuation based on comparables, focusing on metrics like the P/E ratio and EV to EBITDA. This approach involves identifying similar firms, calculating average multiples, and adjusting for unique company traits.

We conclude by linking stock valuation back to corporate investment decisions. Investment projects are treated as cash flow-generating assets, and we guide you through key considerations: cash flow calculation, selecting an appropriate discount rate, and applying sound decision criteria.

Tune in for this comprehensive guide to stock valuation and its essential role in shaping informed corporate investment decisions!