Nations Bank Essay Sample

Purpose: The intent of this instance is to cipher a stock’s monetary value utilizing its past dividends as an index of future dividend growing rates. The pupil must find the stock’s required rate of return ( CAPM ) and future expected dividend growing rate and utilize the Gordon Growth Model to cipher a current monetary value.

1. The equation for CAPM is kj = Rf + [ bj x ( Rm – Rf ) ] where.
kj = required return on plus J.
Rf = riskless rate of return.
bj = beta coefficient for plus J.
Rm = market return.

kj = 6 % + 1. 75 ( 10 % – 6 % )
kj = 13 %

2. The equation for the Gordon Growth Model is. where.
P0 = monetary value of the common stock.
D1 = per portion dividend expected at the terminal of twelvemonth 1.
D0 = most late paid dividend.
Ks = required return on common stock.
g = growing rate in dividends.

To cipher g. we have to presume that future dividend payments will turn at a changeless rate into the hereafter everlastingly. This changeless rate can be estimated
by analyzing the mean growing rate in the yesteryear. On a reckoner.

Let.
PV = $ . 86.
FV = $ 2. 00.
n = 8.

Solve for i. I = the mean growing rate. In this instance i = g = 11. 13 % .

Pluging this growing rate into the Gordon Growth Model.

P0 = $ 2. 00 ( 1 + . 1113 ) = $ 118. 86. 13 – . 1113

3. This clip.
Let.
PV = $ 1. 42.
FV = $ 2. 00.
n = 5.

Solve for i. I = g = 7. 09 % .

Pluging this growing rate into the Gordon Growth Model.

P0 = $ 2. 00 ( 1 + . 0709 ) = $ 36. 24
. 13 – . 0709

4. The Gordon Growth Model. or any other dividend based pricing theoretical account. has major drawbacks in that we are non certain what the true future growing rate in dividends is. As we have merely demonstrated. depending on the period we consider. the stock’s monetary value can fluctuate wildly.

5. The needed rate of return computation has an tremendous consequence on the stock’s monetary value utilizing these types of theoretical accounts. If we assume that Nations Bank’s required rate of return on its common stock is 12 % alternatively of 13 % . the Gordon Growth Model will give a monetary value of

P0 = $ 2. 00 ( 1 + . 0709 ) = $ 43. 62
. 12 – . 0709

This value is non much different. but consider the consequence when the growing rate in dividends is near the needed rate of return on the common stock as is the instance from 1987-1995.

P0 = $ 2. 00 ( 1 + . 1113 ) = $ 255. 47
. 12 – . 1113

In general. the deliberate stock monetary value will be highly sensitive to the needed rate of return when the needed rate of return is close to g.

6. This would be an illustration of a nothing growing stock. The watercourse of payments would be changeless ( rente ) and they would last everlastingly ( sempiternity ) . When this particular instance occurs. a simplified equation can be used.

P0 = D1/Ks = $ 2. 00/ . 13 = $ 15. 38

7. The farther out into the hereafter the dividend payments are received. the less valuable they are in today’s dollars. Using a dividend sum of $ 1. 00 and a price reduction rate of. 13. the present value of these three dividends are $ . 88. $ . 29. and $ . 000004922. severally.