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16.67
Stock Valuation Models
The Constant Growth Model
D4 = D1 (1+g)3 = Rs.4.764
GROWTH?
Stock Valuation Models
The Constant Growth Model
What would an investor be willing to pay for a stock if he just received a
dividend of $2.50, his RRR is 15% and he expects dividends to grow at 5%
per year?
26.25
Stock Valuation Models
Variable Growth Model
• The non-constant
dividend or variable
growth model
assumes that the
stock will pay
dividends that grow
at one rate during
one period, and at
another rate in
another year or
thereafter.
Stock Valuation Models
Variable Growth Model
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
Stock Valuation Models
Variable Growth Model
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 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%
V 2? $ 31.76
Stock Valuation Models
Variable Growth Model
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 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 $ 24.02
V0 ? $ 28.69
A common stock just paid a dividend of
Rs.2. The dividend is expected to grow at
8% for 3 years, then it will grow at 4% in
perpetuity. What is the stock worth if the
required rate of return is 12%?
D n 1
D1 (1 g1 ) r g 2
t
P 1 t
r g1 (1 r ) (1 r ) n
2(1.08) 3 (1.04)
2 (1.08) (1.08) .12 .04
3
P 1 3
.12 .08 (1.12) (1.12) 3
P 54 1 .8966
32.75
3
(1.12)
= Rs. 43.88
The current dividend is Rs.2, supernormal
growth is 20% for 6 years. Thereafter it will
grow at 10%. If the rrr is 15%, value the
stock.
Stock Valuation Models
Free Cash Flow Model
• The free cash flow model is based on the same
premise as the dividend valuation models except that
we value the firm’s free cash flows rather than
dividends.
Stock Valuation Models
Free Cash Flow Model
• The free cash flow valuation model estimates the
value of the entire company and uses the cost of
capital as the discount rate.
• As a result, the value of the firm’s debt and preferred
stock must be subtracted from the value of the
company to estimate the value of equity.
Stock Valuation Models
Free Cash Flow Model
Dewhurst Inc. wishes to value its stock using the
free cash flow model. To apply the model, the
firm’s CFO developed the data given in Table.
Stock Valuation Models
Free Cash Flow Model
Step 1: Calculate the present value of the free cash
flow occurring from the end of 2009 to infinity,
measured at the beginning of 2009.
Stock Valuation Models
Free Cash Flow Model