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Capital Asset Pricing Model and Stock Valuation and Growth Rate

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Using data from our fictitious Company, MT 217 (from attached sheet), we will calculate the expect value of its stock using the Constant Growth Model (attached): Po = D1/(r - g)

To do that we will have to estimate the vales of r, g, and D1.

To estimate the value of r we will use the Capital Asset Pricing Model:

CAPM = Rf + Beta(Rm - Rf)

Where:

Risk Free Rate = Rf = 3.5%

Market Return = Rm = 12%

Beta of BA 217 Corp. = .85

Question 1: Calculate "r".

Next we estimate the value of "g" using the average growth rate of past dividends.

Assume 6 years ago MT 217 paid a dividend of $1.20 and this year they paid a dividend of $1.55, using the Excel RATE formula calculate the average growth rate it took for the dividend to the current level in the period of time.

Question 2: Calculate "g".

Next we estimate the value of D1, the dividend next year as required by the Constant Growth Model.

D1 = Do(1 + g), where Do = the dividend today, $1.55

Question 3: Calculate "D1".

Using your solutions estimate the value of MT 217 Corporation's stock using the Constant Growth Model.

Po = D1/(r - g)

Question 4: Calculate the estimated value or Price Today of MT 217 = "Po".

Finally comment on this question. If the actual market value was BELOW your estimated value of MT217, and you were highly confident in your assumptions, what action might you take?

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Solution Summary

Estimating the growth rate of a fictitious company and its value.

$2.19