PROJECT OVERVIEW

Calculate a stock price using its past dividends as an indicator of future dividend growth rate. You will determine the stock’s required rate of return (CAPM) and future expected dividend growth rate. You will use the Dividend Growth Model to calculate a current theoretical value of the stock price for Asset J.

DELIVERABLE

Complete problems 1 through 8 and answer questions in an essay format when required. You will need to use the answers in question 1 and 2 to answer question 3.

Please calculate CAPM of Asset J with the following information:

where,

kj = required return on asset j,

Rf = risk-free rate of return, (6%)

bj = beta coefficient for asset j, (1.75)

Rm = market return. (10%)

The equation for CAPM is kj = Rf + [bj x (Rm – Rf)]

kj = Solve for required return on asset j (kj is CAPM)

Calculate the growth rate of Asset J dividends, we have to assume that future dividend payments will grow at a constant rate into the future forever. This constant rate can be estimated by calculating the average growth rate from the past dividends. Calculate Asset J’s dividend growth rate for the past 8 years.

Year

1

2

3

4

5

6

7

8

Dividend

$0.86

$2.00

Let:

Dj = $ .86,

D

8 = $2.00,

n = 8.

The equation for calculating the growth rate of dividends is the future value equation. FV=PV(1+i)n

where:

Dj = PV,

D8 = FV,

n = time

Growth Rate = I

Calculate the growth rate: Remember you have to change the Future Value Equation to find N or use your calculator.

Calculate Assets J’s theoretical value of the common stock price. The equation for the Dividend Growth Model is,

V = (Current Dividend * (1 + Dividend Growth))(Required Return – Dividend Growth)

where:

V = price of the common stock,

Current Dividend = Most recently paid dividend,

Required return on common stock = CAPM

Dividend Growth = Growth Rate of Dividend

This time, calculate the growth rate of Asset J dividends over the past five years if the dividend grew by the following:

Year

1

2

3

4

5

Dividend

$1.42

$2.00

Let:

D

1= $1.42,

D

8= $2.00,

n = 5.

The equation for calculating the growth rate of dividends is the future value equation. FV=PV(1+i)n

where:

Dj = PV,

D8 = FV,

n = time

Growth Rate = I

Use the new growth rate of Asset J’s dividend in question four and calculate the theoretical value of the common stock of Asset J. Assume Asset J’s required return on the common stock (CAPM) remained the same as in question 1. Use the same Dividend Growth Model equation as in question 3 to find the new theoretical value of the common stock of Asset J.

V = (Current Dividend * (1 + Dividend Growth))(Required Return – Dividend Growth)

The required rate of return calculation has an enormous effect on the stock’s price using these types of models. If we assume that Nations Bank’s required rate of return on its common stock (CAPM) is 12% instead of 13%, what would the Constant Dividend Growth Model Price yield?

You need to plug in the dividend growth rates from appropriate results above.

V = (Current Dividend * (1 + Dividend Growth))(Required Return – Dividend Growth)

Is there a significant difference? Please explain your answer.

What are some of the drawbacks using Dividend Growth Model, or any other dividend based pricing model? Explain in essay format.

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