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Unformatted text preview: Constant Growth Model Assumptions o Dividends are ~..L.I.l..J.L..&.:..:-L::L_ 8The growth rate is .....l~!...l...~~~:.... eThe discount rate is ~~~1o..C:::'- __ than the growth rate. • If these assumptions are reaso'rt1e, then we can use Po = __ 1 _ r-g Constant Growth Model Revisited • We can re-state the Constant Growth Model in a more general form: D, ~ Po = (1 - b)EPS I r-ROE ·b '---v---" g Example • Suppose VPI,Inc. is expected to have EPS, = $1 and a required rate of return of I2Y.. VPI has traditionally paid out 60% of earnings as dividends . • Would your answer change if you realized VPI cannot reinvest funds in new projects at more than 12%? \) _ ~ ~ )l') o - • \ 1. - t.\1. .• 1.\) \> o -:: \\ <t)..~3 Why do a firm's dividends grow? • Because a firm's earnings grow. Why? • Because a firm reinvests shareholder funds to expand or to undertake new projects. • Further, the funds are reinvested in profitable projects, i.e., positive NPV projects....
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This note was uploaded on 09/07/2011 for the course FINANCE 320 taught by Professor Sapp during the Fall '10 term at Iowa State.
- Fall '10