Stock Valuation and CAPM Concepts

What is the dividend growth rate of ABC Company?

What is the required rate of return for ABC Company?

Using the Gordon Growth Model, what formula represents the calculation for Po?

What does the Gordon model primarily focus on in valuation?

What does D1 represent in the formula Po = D1 / (r - g)?

In the Gordon model, which component represents the current dividend?

What is the value of the share (Po) calculated for ABC Company?

What value is used in the Gordon model to signify the required rate of return?

If an investor expects a firm’s dividend to grow at a rate of 5%, what is the term for this growth rate in the Gordon model?

If the required rate of return is higher than the growth rate of dividends, what implication does this have under the Gordon model?

Stock Valuation

Stock represents corporation fundraising
Investors own CS share and receive dividends
Stock valuation aims to determine the optimal selling price for a company's shares
Constant growth model (Gordon model) estimates stock value based on constant dividend growth.
Formula: P₀ = D₁ / (rₐ - g)
P₀ = current stock price
D₁ = next year's dividend
rₐ = required rate of return
g = constant growth rate
Example: ABC Company's last dividend is 1.60, annual growth is 10%, and required rate is 16%. Stock value = 28.27 EGP

Capital Asset Pricing Model (CAPM)

CAPM helps determine the required rate of return for an investment
Formula: rⱼ = Rf + [βⱼ × (rm - Rf)]
rⱼ = required return on asset j
Rf = risk-free rate
βⱼ = beta of asset j
rm = market return
Example: A corporation with a beta of 1.5, Rf = 12%, and rm = 16% has a required return of 18%.
Market risk premium (rm - Rf) = 4%
Security risk premium (βⱼ × (rm - Rf)) = 6%

Capital Budgeting and Cost of Capital

Cost of capital is the minimum return needed for a capital budgeting project.
It includes costs of equity financing and debt financing.
Weighted average cost of capital (WACC) is the average of the cost of all capital sources
Formula WACC = (w₁r₁) + (wp rp) + (ws rs)
w₁ = weight of debt
wₚ= weight of preferred stock
wₛ= weight of common stock
r₁ = cost of debt
rp = cost of preferred stock
rs = cost of common stock

Cost of Debt

Company calculates the cost of debt considering interest payments.
The after-tax cost of debt is calculated using the formula: rᵢ = rₐ x (1 - T), where rᵢ = after-tax cost of debt, rₐ = before-tax cost of debt, and T = tax rate.

Cost of Preferred Stock

Cost of preferred stock (rp) is the ratio of the dividend to the price of preferred stock

Explore the key concepts of stock valuation and the Capital Asset Pricing Model (CAPM). This quiz covers essential formulas, including the Gordon growth model for stock pricing and how CAPM calculates the required rate of return for investments. Ideal for finance students looking to deepen their understanding of these foundational topics.