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·         Determine the value of a share of common stock when: (1) dividends are expected to...

·         Determine the value of a share of common stock when: (1) dividends are expected to grow at some constant rate, and (2) dividends are expected to grow at some super-normal, or no constant, growth rate.

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Expert Solution

Constant Growth Stock Valuation

A constant growth stock is a stock whose dividends are expected to grow at a constant rate in the forseeable future. This condition fits many established firms, which tend to grow over the long run at the same rate as the economy, fairly well. The value of a constant growth stock can be determined using the following equation:

P= D(1+g)/(r-g), where D is the current dividend, g is the growth rate of dividends and r is the discount rate.

Nonconstant Growth Stock Valuation

Many firms enjoy periods of rapid growth. However, the period of rapid growth cannot continue indefinitely. Eventually, competitors will enter the market and catch up with the firm.These firms cannot be valued properly using the Constant Growth Stock Valuation approach.To value such firms we use a more general approach which allows for the dividends/growth rates during the period of rapid growth to be forecast. Then, it assumes that dividends will grow from that point on at a constant rate which reflects the long-term growth rate in the economy.

P= +  (D(t+1)/(r-g))(1+r)^(-T), where D(t) is the dividend at time t, g is the growth rate of dividends and r is the discount rate

jeff jeffy answered 2 years ago
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