KIC000047

# KIC000047 - Constant Growth Model Assumptions oDividends...

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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. • This leads to earnings growth. and also growth in investments and dividends .

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