Zero Growth Model

1. Zero Growth (Constant Dividend) Model A. Solving for Price: V = D/k, where D = dividend and k = required return What would an investor be willing to pay for a stock if she expected to receive a dividend of $2.50 each year indefinitely and her required return is 15%? D 2.50 $ k 15.00% V? 16.67 $ B. Solving for Return: k = D/V What rate of return would an investor expect if the current price of a stock is $119 and she expected the firm to pay a constant dividend of $4/year? V 119.00 $ D 4.00 $ k? 3.4% Valuation (Note: The tables below have been written using formulas which allow you to alter the information or assumptions.)or assumptions.)1. Constant Growth Model A. Solving for Price: V = D0(1+g)/k-g = D1/(k-g) , where D0 = current dividend, k = required return, and g = growth rate What would an investor be willing to pay for a stock if she just received a dividend of $2.50, her required return is 15%, and she expected dividneds to grow at a rate of 5% per year. D0 2.50 $ k 13.00% g 4.00% V? 28.89 $ B. Solving for Return: k = D0(1+g)/V + g = D1/V + g What is my expected return on a stock that costs $26.50, just paid a dividend of $2.50, and has an expected growth rate of 5%? D0 2.50 $ V 26.25 $ g 5.00% k? 15.00% Valuation (Note: The tables below have been written using formulas which allow you to alter the information or assumptions.)required return,1. Non-Constant Growth Model A. Solving for Price: This model involves the computation of year-to-year dividends which are then dicounted at the investors required rate of return. What would an investor be willing to pay for a stock if she just received a dividend of $2.50, her required return is 15%, and she expected dividneds to grow at a rate of 10% per year for the first two years, and then at a rate of 5% thereafter. Step 1: Compute the expected dividends during the first growth period. g 10.0% D0 2.50 $ D1 2.75 $ D2 3.03 $ Step 2: Compute the Estimated Value of the stock at the end of year 2 using the Constant Growth Model D2 3.03 $ k 15.00% g 5.00% V2? 31.76 $ Step 3: Compute the Present Value of all expected cash flows to find the price of the stock today. Cash PV at Flow 15% 1 D1 2.75 $ 2.39 $ 2 D2 3.03 $ 2.29 $ 3 V2? 31.76 $ 20.88 $ V0 ? 25.56 $ Valuation (Note: The tables below have been written using formulas which allow you to alter the informatins or assumptions.)Example: If the rate of return on U.S. T-blls is 5%, and the expected return for the S&P 500 is 15%, what would be the required return for Microsoft with a beta 1.5, and Florida Power and Light with a beta of 0.8?MSFT FPL rf 5.0% 5.0% rm 15.0% 15.0% B 1.5 0.8 Answer k? 20.0% 13.0% (Note: When evaluating the impact of changes in variables, keep in mind that changes in the risk-free rate must be accompanied equivalent changes in the market return. Required Return k = rf + (rm -Rf)B