Final answer:
The theoretical value of a common stock held for multiple periods is computed using Present Discounted Value (PDV), which discounts expected future profits at a chosen interest rate and divides the total by the number of shares to determine the price per share.
Step-by-step explanation:
The theoretical value of a share of common stock that is to be held for multiple periods can be determined using the concept of Present Discounted Value (PDV). This involves calculating the present value of expected future profits or dividends the stock will generate, and then summing those present values to find the total worth of the stock in today's terms.
To calculate the PDV, you must decide what interest rate (also known as the discount rate) is appropriate to discount future amounts. The interest rate reflects the time value of money, meaning that money available in the present is worth more than the same amount in the future due to its potential earning capacity.
Let's take the case of a company expected to make profits of $15 million in the present, $20 million in one year, and $25 million in two years, where the expected interest rate is 15%. The PDV calculations for each of these amounts would be done separately since they are received at different times.
Once all PDVs are calculated and summed, you would divide this total by the number of shares to find the price per share. In this scenario, if the total PDV of profits is $51.3 million and there are 200 shares, dividing yields a per-share value of $0.2565 million, or about $256,500 per share.
In real financial decision making, these future profits and the correct interest rate to apply are often estimated—highlighting why different investors may disagree on the value of a share.