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Capital Asset Pricing Model and Stock Valuation and Growth Rate

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