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GNC: Dividend Growth, CAPM, APT

GNC company.
1. Which of the three models (dividend growth, CAPM, or APT) is the best one for estimating the required rate of return or discount rate of GNC? And Why?
2. Based on analysis and findings, what would you recommend to the board of directors of GNC company?

Please examine:
-the ease of use of these three models in GNC
-accuracy of each of these models for GNC
-how realistic the assumptions of each model are for GNC?

Solution Preview

Step 1
Of the three models, the dividend growth, CAPM or the APT, the best one for estimating the required rate of return is the CAPM.

We first consider the dividend growth rate which determines the value of the stock based on a future series of dividends that grow at a constant rate. The formulae is Stock Value(P) = D/ (k- G), where D is the expected dividend per share one year from now, k is the required rate of return for investor, and G is the growth rate in dividends. The reason why we do not favor this model is that it assumes that dividends grow at a constant rate in perpetuity; it also assumes that it is possible to know what dividend the company will pay in one year's time.
We next consider the arbitrage pricing theory. This theory holds that the expected return of a financial asset can be modeled as a linear function of various macro-economic factors or theoretical market indices. The sensitivity to changes in each factor is measured by a factor specific beta coefficient. The problem with using the APT model is that it ...

Solution Summary

This posting gives you a step-by-step explanation of the estimation of the required rate of return. The response also contains the sources used.

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