SpreadSpreadsheets are especially useful for computing stock value under differe

Question

SpreadSpreadsheets are especially useful for computing stock value under different assumptions. Consider a firm that is expected to pay the following dividends:

     Year 1        2          3          4          5          6       

            $1.20   $1.20   $1.50   $1.50   $1.75   $1.90   and grow at 5 percent thereafter

A. Using an 11 percent discount rate, what would be the value of this stock?

B. What is the value of the stock using a 10 percent discount rate? A 12 percent discount rate?

C. What would the value be using a 6 percent growth rate after year 6 instead of the 5 percent rate using each of these three discount rates?

D. What do you conclude about stock valuation and its assumptions?

Part 1 of this Assignment to be posted to Turnitin should be a Word document that explains your responses to the 4 subpart questions described above. Sub part D asks for your personal views on stock valuations. It is my expectation that the majority of your explanations be devoted to that subpart of the assignment.

Explanation / Answer

A.)

the formula applied is D1 divided by Ke or cost of equity or required rate of return as the case may be here - growth rate. So you can see the movement of shares accordingly.

B.)

Discount rate is taken as 10%. Cost of equity is 10%.

2.

Discount rate is 12%, as well as the cost of equity.

C.) For discount rate of 12% value will change to 33.567 otherwise calculation will remain the same for the other years as presented earlier. similarly, for discount rate of 10% value will change to 50.35 rest calculation will remain same as presented in the table. For discount rate of 11% value will change to 40.28 other value.

D.) Lower the discount rate higher is the valaution of the stock as calculated this shows the relationship between stock and its required rate of return on cost of capital although higher growth will lead to low stock price and low growth will lead to higher stock valaution but, in reality high growth implies high rate of return for the investor as well as company, which is not taken into consideration by the gordon constant growth formula, which assumes stock will be paid every year, but in reality very few companies distribute dividend and discount rate factor on dividend distributed by the company is not taken into consideration, that is dividend paid today is measured as same when distributed after 1,2,3,4,5 and years ahead. dividend should be discounted as per discount rate and then only calculated as price of machine or asset is valued combined with the price as declared dividend of rupee 3 per share has less worth with the passage of time. Moreover, risk of losses in the form of bad debt and stock devalaution is also not considered as well.

Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Dividend 1.200 1.200 1.500 1.500 1.750 1.900 Discount rate @ 11% 0.901 0.812 0.731 0.659 0.593 .535 Valuation of dividend in present 1.135 0.974 1.097 0.988 1.039 0.543 Growth 5% of dividend + dividend 1.260 1.260 1.575 1.575 1.855 2.014 Current stock price 21.000 21.000 26.250 26.250 30.917 33.567

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