Pick a company that pays dividends, then calculate the ...



Pick a company that pays dividends, then calculate the expected growth rate of your company using the CAPM.

JLT: We are doing DOW CHEMICAL ... (symbol DOW). This may be confusing because it says GROWTH RATE ... when we generally think of the CAPM as generating a Rate of Return demanded by the market ... they are the same thing.

CAPM says Rdow = Rf + BETAdow(Rm - Rf)

Remember I told you to start by assuming:

Rf = 4%

Rm = 12% ... now go find Dow's Beta on the web site I sent you to .... with that you can complete the first part of the question.

Rdow = 4% + BETA dow(12% - 4%)

just find that Beta and you will have the first part finished.

Once this task is complete, calculate the expected growth rate using the Constant Growth Model.

JLT: DOW DiViDEND... in 2001 Dow Chemical paid a dividend of $1.29 per share .... in 2007 they paid $1.63 per share ... right now 2008 is forecast at 1.68 but of course there is still some time left in 2008.

So to get that dividend growth rate we can use our Excel Rate function or our financial calculator... like this

PV = -1.29

FV = 1.63

n = 6

PMT = 0

Find i (RATE) ... with that you will get the dividend growth rate for the constant growth model. .... remember ... that little "g".

Then on the Constant growth model we would say

Price of Dow = next years dividend/ (Rdow - g)

with what I have given you, remember we just calculated Rdow with the CAMP .... and we just calculated "g" using the RATE function or our financial calculator. We can determine next years dividend by applying that growth rate to $1.63 ... then do the math so see what the value of Dow's stock should be based on our assumptions.

What assumptions you say .... 4% Rf and 12% Rm.

Solution

Using CAPM:

Rf = 4%

Rm = 12%

Beta = 0.8

Since:

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Where RE is the Rate of Return on Stock

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= 10.4%

Growth rate (g) = 3.98% (Please see the attached excel sheet for the calculations)

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= [pic]

= $26.17

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