uppose that the consensus forecast of security analysts of NoWork Inc. is that earnings next year will be E1 = $10.00 per share. The company tends to plow back 50% of its earnings and pay the rest as dividends. The CFO estimates that the company’s growth rate will be 8% from now on. (a) If your estimate of the company’s required rate of return is 12%, what is the equilibrium price of the stock? (b) You observe that the stock is selling for $120.00 per share. Suppose you believe that the market price is right. What must you conclude about either (i) your estimate of the stock’s required rate of return, (ii) the CFO’s estimate of the company’s future growth rate, or (iii) the forecast of earnings from the analysts? (c) Suppose there is uncertainty about the stock’s dividend growth rate. With probability 1/3 the growth rate will be 10%, with probability 2/3 it will be 7%. What are the respective market values under the two different growth rates?
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
2. Suppose that the consensus
(a) If your estimate of the company’s required
(b) You observe that the stock is selling for $120.00 per share. Suppose you believe that the market price is right. What must you conclude about either (i) your estimate of the stock’s required rate of return, (ii) the CFO’s estimate of the company’s future growth rate, or (iii) the forecast of earnings from the analysts?
(c) Suppose there is uncertainty about the stock’s
(d) What is the fair price of the stock given the probabilities above?
(e) What is the expected growth rate for the stock? Given your calculations, which security is more valuable for an investor: the stock with a 8% growth rate for sure or the stock described in part (c) with an uncertain growth rate.
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