Question answer Essay Example | Topics and Well Written Essays - 750 words - 1

Question answer - Essay Example The details mentioned in the data require that the long run rate of return must be calculated using the formula of present value of dividend using Dividend Discount Model. . PV GROWING PERPETUITY (DIVIDEND DISCOUNT MODEL) Data: Present Value of Share PV O USD.150 Dividend for the First Year D1 USD. 7 Growth g 0.04 Rate of return r ? FORMULA REARRANGED In the above provided case since the value of price was already provided, the formula for such payments has been manipulated and rate of return has been evaluated. The formula for DDM for the current price of shares is rearranged for the calculation of rate of the return. Applying this arrangement, the long term rate of return for the company is as follows: r 0.086667 r 8.67% Hence, the expected long run rate of return is 8.67%.This refers that when company is paying 60 percent of the earning as dividend to shareholders and investors are pricing the share at USD.150, the required rate of return in the long terms is 6.67%. This percentag e assumes that price is based on incorporating all information about the company. The formula can be summarized as the ratio of the cash flows of dividends received in the future periods by the net difference of the discount rate and the growth rate. This formula is developed on the concept that current price of stocks are a series of payments which grows as dividend perpetually at a constant rate. . The formula assumes that the payments of dividends are received for an infinite period at constant growth rate. For the calculation of Present value it is very important that the discount rate used for the calculation is higher than the growth rate.. PART B Dividend discount model assumes that the price of stocks follows constant growth indefinitely across the life of the company (McLaney, 2009). However, on actual grounds the growth of the company varies from time to time. For instance, in the above case, The Company aims to expand and therefore, therefore, has changed the dividend pol icy across for five years (Ross, Westerfield, and Jordan, 2009). In such case, two stage dividend discount model is used to evaluate the price of the stock in current year. In such a system of two staged growth, the price of stocks are measured by calculating the present value of dividend streams by discounting it with required rate of return. For the second staged growth, the price of a stock is calculated for the year in which growth has changed and is then discounted to current year (Gitman, 2003). In the final stage, the present values of two staged dividend growth are combined. The following formula is used for such cases: Following this, procedure the price of stock in second case is USD. 74.99. Given below is the calculation for the case: PART B DIVIDEND CALCULATION STAGE ONE STAGE 2 YEAR 1 2 3 4 5 6 7 Dividend MENTIONED IN CASE ONE 7 Â   Â   Â   Â   Â   Â   earning (calculated using Dividend Information of Case (1) and then growth applied $ 11.67 $ 12.13 $ 12.62 $ 13.1 2 $ 13.65 $ 14.19 $ 14.76 Reinvested $ 10.50 $ 10.92 $ 11.36 $ 11.81 $ 12.28 $ 4.26 Â   Â   Â   Â   Â   Â   Â   DIVIDEND WITH NEW % OF GROWTH Dividend $ 1.17 $ 1.21 $ 1.26 $ 1.31 $ 1.36 $ 9.94 $ 10.33 Â   Â   Â   Â   Â   Â   Â   Â   The above table determines that to get base year information, it is assumed that the earning of company for year one remains same as it is provided in the case. Hence, price is as follows: PRICE Â   Â   Â   Â   Â   Â   Â   Â   Â   PV: dividend 1 / (1-R)^t PV: dividend 7 / (r-g)