Question

your answer must have at least 300 words

- How do we determine stock returns and values when the dividend is increasing at a fixed rate?

- How do we determine stock returns and values when the dividend is unknown (but we do have a 20 year history of dividend payments)?

- How do we adjust our calculations to take the stock risk into account?

Answer 1

Answer 1:

When the dividend increases at a fixed rate then the use of constant rate of growth in dividend shall be used to ascertain the value of stock. Generally the following formula is used to determine the value of a stock when the dividend is expected to increase at a fixed rate;

Expected dividend at the end of year 1 / (Cost of equity – rate of growth)

The return in such stock is measured using the following equation;

Expected dividend at the end of year 1 X 100 / Cost of each share

Note: Multiplication of 100 is to get a percentage return.

Answer 2:

In such case the average rate of dividend can be calculated by aggregating the amount of dividend paid over the last 20 years dividing by the number of years. The average amount of dividend can be divided by the average stock price to determine the rate of return on stock. To determine the value f the stock the average growth rate over the last 20 years can be calculated. The rate of growth along with cost of capital shall be used to ascertain the value of share.   

Answer 3:

The stock risk is the risk of uncertainty of an organization working in the market. There are number of risks that are associated with the operations and workings of an organization these include the risk of uncertainties which are associated with the business of an organization. Use of beta is generally made to incorporate the risk element into the calculation of rate of return and value of a particular stock. Beta is generally determined based on the uncertainties and variation of revenue and profits of an organization over the years. Generally a beta of 1 indicates that an organization has equal risk as compare to the risk of overall market. A beta of less than 1 indicates that an organization has relatively lower risk compare to the overall market risk and opposite is the case in case of a beta in excess of 1.