Constant growth ratesOne of the most important components of stock valuation is a firm’s estimated growth rate. Financial statements provide the information needed to estimate the growth rate.Consider this case:Robert Gillman, an equity research analyst at Gillman Advisors, believes in efficient markets. He has been following the mining industry for the past 10 years and needs to determine the constant growth rate that he should use while valuing Pan Asia Mining Co.Robert has the following information available:•Pan Asia Mining Co.’s stock (Ticker: PAMC) is trading at $16.25.•The company’s stock is expected to pay a year-end dividend of $0.78 that is expected to grow at a certain rate.•The stock’s expected rate of return is 7.80%. Q1. Based on the information just given, what will be Robert’s forecast of PAMC’s growth rate? a. 7.75% b. 3.00% c. 4.50% d. 2.49% Q2. Which of the following statements accurately describes the relationship between earnings and dividends when all other factors are held constant? a. All else being equal, growth in dividends requires growth in earnings. b. Long-run earnings growth will decrease when firms retain earnings and reinvest them in the business. c. Retaining a higher percentage of earnings will result in a lower growth rate.

Name: Constant growth ratesOne of the most important components of stock val
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Description: Constant growth ratesOne of the most important components of stock valuation is a firm’s estimated growth rate. Financial statements provide the information needed to estimate the growth rate.Consider this case:Robert Gillman, an equity research anal

As per Gordan's dividend growth model (DDM), the dividend is relevant and it affects the price of the shares. Under DDM, the share of a company is PV of the total of all its future dividends that share is expected to provide and discounting it by required rate of return.. Discounting of future dividends is done using the required rate of returnWhen there is growth over the course of time, the value of share also increases.As per DDM, the required rate of return is computed as per below formulaP0=(D1)/(Ke-g)D1 =(Ke-g)*P0(D1)/(po)= (Ke-g)Ke= (D1)/(po)+gHere G=growthKe=required rate of return D1=Dividend for next period= D0*(1+g)P0= Current price of shareIf we want to find the growth from above formula, we will reverse compute the above formula.Using the DDM, we will put the values in below formula to arrive the growth rateKe=(D1/Po)+g7.8%=(0.78/16.25)+g7.8%=4.8%+gg=7.8%-4.8%g=3.00%Hence growth rate is 3 percent. (Option B) is correctPart (b) The correct option is (a)a. All else being equal, growth in dividends requires growth in earnings.The relationship between earnings and dividends when all other factors are held constant, is that dividends are paid out of earnings. If earnings are more, then dividends can be distributed more.The higher the earnings, the higher the dividend.Part (a) The correct option is (B).Hence the growth rate is 3%Part (b)The correct option is (a) for relationship between earnings and dividendAll else being equal, growth in dividends requires growth in earnings.

Answered: Q1. Based on the information just…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Constant growth rates

One of the most important components of stock valuation is a firm’s estimated growth rate. Financial statements provide the information needed to estimate the growth rate.

Consider this case:

Robert Gillman, an equity research analyst at Gillman Advisors, believes in efficient markets. He has been following the mining industry for the past 10 years and needs to determine the constant growth rate that he should use while valuing Pan Asia Mining Co.

Robert has the following information available:

•	Pan Asia Mining Co.’s stock (Ticker: PAMC) is trading at $16.25.
•	The company’s stock is expected to pay a year-end dividend of $0.78 that is expected to grow at a certain rate.
•	The stock’s expected rate of return is 7.80%.

Q1. Based on the information just given, what will be Robert’s forecast of PAMC’s growth rate?

a. 7.75%

b. 3.00%

c. 4.50%

d. 2.49%

Q2. Which of the following statements accurately describes the relationship between earnings and dividends when all other factors are held constant?

a. All else being equal, growth in dividends requires growth in earnings.

b. Long-run earnings growth will decrease when firms retain earnings and reinvest them in the business.

c. Retaining a higher percentage of earnings will result in a lower growth rate.

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