Valuation

(Note: The tables below have been written using formulas which allow you to alter the information or assumptions.)

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%
n or assumptions.)
 Valuation
(Note: The tables below have been written using formulas which allow you to alter the information 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

k = D0(1+g)/V + g = D1/V + g
B. Solving for Return:

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? #NAME?
or assumptions.)
 Valuation
(Note: The tables below have been written using formulas
which allow you to alter the informatins or assumptions.)

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
 Required Return
k = rf + (rm - Rf)B

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.