Dividend Growth Model Essay

1. Dividend Growth sampleThe basic presumption in the Dividend Growth nonplus is that the dividend is expected to grow at a constant stray. That this growth consider testament not change for the duration of the evaluated period. As a result, this whitethorn skew the resultant for companies that ar experiencing rapid growth. The Dividend Growth Model is fall(a) in suited for those stable companies that fit the model. Those that atomic number 18 developing quickly or that dont pay dividends do not fit the self-assertion parameters, and thus this model cannot be use. In this model, a beau monde may not exceed the market growth rate.In kick inition, since the dividend growth rate is expected to remain constant indefinitely, the other measures of performance inside the lodge are also expected to maintain the same growth rate. If in the current state, the dividend rate is greater that earnings, in time this model will show a dividend payout greater than the earnings of the c ompany. Conversely, if earnings are growing faster than dividends, the payout rate will converge towards zero.In summary, the Dividend Growth Model works well for those companies growing at a rate make up to or lower than that of the economy and have an established and stable dividend payout.In vagabond to estimate the bell of equity utilise the Dividend Growth Model, we patently adjust the models equation for estimating the price of a transport, attached as suchP = D1 / (r g)Where P = the price of the stockD1 = the expected Dividend in wizard yearr = the requisite rate of returng = the expected Growth ConstantBy solving the equation for k we get the followingP(r g) = D1r g = D1 / Pr = (D1 / P) + gTherefore in order to estimate the cost of equity through the Dividend Growth Model, we simply add the constant growth rate and the projected dividend yield in one year.2. Capital asset set ModelThe assumptions used in the Capital Asset Pricing Model (CAPM) are convertible in that they assume an nigh perfect world scenario.Initially, CAPM assumes that all investors have the same rational expectations of returns, and that these returns are in line with the best prediction for future returns as base on the available information. It also makes the assumption that the dividends are paid normally, that assets are fixed, and that the market is efficient and in equilibrium with no inflation or change in the interest rate. CAPM additionally makes the important assumption that the evaluated stock is properly priced and that the work out level has been properly assessed.Another major assumption is that thither are no taxes, transaction fees, or arbitrage opportunities during the evaluation period. This is a huge assumption which is generally incorrect. Almost all proceeding within the market have some sort of tax or fee associated with it.Within CAPM, the required rate of return is found in the following equationr = rf + B (rm rf)Where r = the required ra te of returnrf = the risk free rateB = the stocks Beta valuerm = The grocery returnIn essence CAPM evaluates a stock based on its risk and potential return compared to a risk-free market portfolio.3. CAPM and the Modern Portfolio TheoryModern Portfolio Theory is an go on to balance the risks and rewards of investment portfolios through the use of diversification to lower the risk of the entire portfolio while maintaining high returns. The use of Beta is a attain concept in Modern Portfolio Theory. It uses CAPM as its basis to select investments within a portfolio seeking to mix stocks with both positive and negative Betas to execute a portfolio with a minimal Beta for the group of stocks as a whole. Theoretically, the returns from stocks with both positive and negative betas do not cancel each(prenominal) other out, but rather the portfolio is constructed that the returns are independent of the other stocks held, so far complimentary in accumulation of returns.4. Estimation of Untraded Stocks.The general standard for estimating the cost of equity of a non-traded company is through the Market Approach. The basis of this approach is that the stocks of publicly traded companies, engaged in the same of like business, are a valid indicator of performance for a non-traded company.Under the Market Approach, on that point are two commonly used valuation regularitys the signpost human race Company method, and the Merger and Acquisition Method.The Guideline creation Company method consists of finding a parallel company and applying that companies financial data to the non-traded company. A company chosen to provide a reasonable basis for affinity should ideally be in the same industry as the non-traded company. However, if there are no companies with sufficient data available, as company in a similar industry may be selected. A similar industry should be one that had identical investment characteristics such as markets, growth, and product lines. The difficulty in exploitation this method lies in identifying a public company that is sufficiently comparable.According to the American Institute of certifiable Public Accountants Statement onStandards for Valuation Services, the following should be considered when using rule of thumb companiesA. Price information of the signpost company must be cerebrate to the appropriate underlying financial data of the company evaluatedB. The valuation ratios for the guideline company and the comparative analysis of qualitative and quantitative factors should be used together to determine appropriate valuation ratios to be applied to the capacity company.C. Several valuation ratios may be selected for application to the subject company, and several(prenominal) value indications may be obtained. The appraiser should consider the relative wideness accorded to each of the value indications used in arriving at the opinion or conclusion of value.D. To the extent that adjustments for dissimilari ties with respect to minority and control, or marketability, have not been made earlier, appropriate adjustments for these factors must be made, if applicable.The key to obtaining the most absolute results when using the Guideline Company Method is to use the most comparable company as the guideline company. The closer to the evaluated company in all areas, the more accurate the result.The merger and acquisition method evaluates a company based on actual merger and acquisition transactions that implicate entire companies or controlling interests in companies. This method may accommodate companies that were either public or private prior to the control transaction. When using this method, all of the underlying information relating to a particular merger or acquisition may not be known. The motives of the buyer or trafficker may cause the transaction amounts to be skewed this will be transparent to the evaluator and can cause an inaccurate evaluation.By using either of the Mar ket Approach methods, it is still a best guess based on the best available information. The more accurate and comparable the comparison study is, the better the resulting evaluation.REFERENCES1. Booth, Laurence. Time to Pass the Old housemaid? http//www.investmentreview.com/archives/1999/spring/oldmaid.html2. Damodaran, Aswath. Dividend Discount Models.New York University, Leonard N. Stern School of personal line of credithttp//pages.stern.nyu.edu/adamodar/pdfiles/valn2ed/ch13.pdf3. Citizendium.org. bell of equity.http//en.citizendium.org/wiki/Cost_of_equity4. Ivkovic, Inya. CAPM Where Market Theories Converge and Clash.suite101.com. Sep 29, 2007http//investment.suite101.com/article.cfm/capm_assumptions_and_limitations5. Investopedia.com. Financial Concepts Capital Asset Pricing Model.August 2007http//www.investopedia.com/university/concepts/concepts8.asp6. Wallener, Damir. What is Modern Portfolio Theory?http//www.investopedia.com/university/concepts/concepts8.asp7. The America n Institute of Certified Public Accountants (AICPA). Statement onStandards for Valuation Services.http//bvfls.aicpa.org/NR/rdonlyres/672E1DD4-2304-47CA-8F34-8C5AA64CB008/0/SSVS_Full_Version.pdf8. Wise, Richard M. Caveats in Using Guideline Company Transactional Data in Valuing a Business.Quarterly Journal of the Business Valuation Committee of the American Society of Appraisers.Vol. 22, No. 1, March 2003http//www.wbbusval.com/ English/pdf/BVR4-Caveats-Guideline-Cos-March03.pdf9. Pratt, Shannon P. Business Valuation Body of Knowledge Workbook, 2nd Edition.ISBN 978-0-471-27066-9. Paperback. 192 pages. January 2003