The blue stair-step line depicts the value of future stock dividends. The orange stair-step line depicts the present value of those future dividends discounted by rs for a stock with initial dividend D0 = $1.15 and an anticipated growth rate of g = 4%. Use the slider to change rs and observe the corresponding changes in the equilibrium price of the stock. \large \hat P_0 = \sum_{t=1}^{\infty} PV D_t = \frac {D_0 (1+g)} {r_s - g} = \frac {\$1.15(1+0.04)} {0.08 - 0.04} = \$29.90P^0=∑t=1∞PVDt=rs−gD0(1+g)=0.08−0.04$1.15(1+0.04)=$29.90 1. If rs increases to 10%, what would be the value of the constant growth stock? (Note: D0 is $1.15 and the expected constant growth rate g = 4%.) $29.90 $19.93 $10.87 Undetermined 2. When rs increases from, say, 8% to 10%, the value of the constant growth stock: Increases because the interest rate is higher. Decreases because its dividends are being discounted at a higher rate. Remains the same because it is a "constant growth" stock. Might either increase or decrease. 3. Move the slider so that rs is 12%. If the stock were selling on the market for $15.50, would you buy it? (Note: D0 is $1.15 and the expected growth consstant rate g = 4%.) Yes, it is a bargain. No, the stock is overvalued, as the expected stock price is only $14.95. Not enough information to determine whether it would be a good buy. 4. The slider for rs is limited to a minimum of 4.1% so that rs is always greater than g. Move the slider to the minimum and observe how the present value of the stock changes. Must rs be greater than g? No reason rs needs to be greater than g because the formula adjusts the value of the stock appropriately. Yes, because if rs were not greater than g, then the graph would be too large to display easily. Yes, because if rs = g, then the formula divides by zero, producing an infinite value.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Exploring Finance: Constant Growth Stock.
Constant Growth Stock
Conceptual Overview: Explore how the value of a stock changes as a function of the discount interest rate.
The blue stair-step line depicts the value of future stock dividends. The orange stair-step line depicts the
1. If rs increases to 10%, what would be the value of the constant growth stock? (Note: D0 is $1.15 and the expected constant growth rate g = 4%.)
- $29.90
- $19.93
- $10.87
- Undetermined
2. When rs increases from, say, 8% to 10%, the value of the constant growth stock:
- Increases because the interest rate is higher.
- Decreases because its dividends are being discounted at a higher rate.
- Remains the same because it is a "constant growth" stock.
- Might either increase or decrease.
3. Move the slider so that rs is 12%. If the stock were selling on the market for $15.50, would you buy it? (Note: D0 is $1.15 and the expected growth consstant rate g = 4%.)
- Yes, it is a bargain.
- No, the stock is overvalued, as the expected stock price is only $14.95.
- Not enough information to determine whether it would be a good buy.
4. The slider for rs is limited to a minimum of 4.1% so that rs is always greater than g. Move the slider to the minimum and observe how the present value of the stock changes. Must rs be greater than g?
- No reason rs needs to be greater than g because the formula adjusts the value of the stock appropriately.
- Yes, because if rs were not greater than g, then the graph would be too large to display easily.
- Yes, because if rs = g, then the formula divides by zero, producing an infinite value.
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