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Unformatted text preview: m. In some states, the preemptive
right is automatically included in every corporate charter; in others, it is necessary
to insert it specifically into the charter. b. 1. Write out a formula that can be used to value any stock, regardless of its
dividend pattern. Answer: The value of any stock is the present value of its expected dividend stream:
Ö
P0 = 1 (1 rs ) t 2 (1 rs ) 3 (1 rs ) 3 . g (1 rs ) g . However, some stocks have dividend growth patterns which allow them to be valued
using shortcut formulas. Mini Case: 7  16 b. 2. What is a constant growth stock? How are constant growth stocks valued? Answer: A constant growth stock is one whose dividends are expected to grow at a constant
rate forever. ³Constant growth´ means that the best estimate of the future growth rate
is some constant number, not that we really expect growth to be the same each and
every year. Many companies have dividends which are expected to grow steadily
into the foreseeable future, and such companies are valued as constant growth stocks.
For a constant growth stock:
D1 = D0(1 + g), D2 = D1(1 + g) = D0(1 + g)2, and so on.
With this regular dividend pattern, the general stock valuation model can be
simplified to the following very important equation:
Ö0 = 1 rs g = D 0 (1 g)
.
rs g This is the wellknown ³Gordon,´ or ³constantgrowth´ model for valuing stocks.
Here D1, is the next expected dividend, which is assumed to be paid 1 year from now,
rs is the required rate of return on the stock, and g is the constant growth rate. b. 3. What happens if a company has a constant g which exceeds its rs? Will many
stocks have expected g > rs in the short run (i.e., for the next few years)? In the
long run (i.e., forever)? Answer: The model is derived mathematically, and the derivation requires that rs > g. If g is
greater than rs, the model gives a negative stock price, which is nonsensical. The
model simply cannot be used unless (1) rs > g, (2) g is expected to be constant, and
(3) g can reasonably be expected to continue indef...
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 Spring '12
 jamnadas
 Valuation

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