Purchase Solution

CAPM and the Constant Dividend Growth Model

Not what you're looking for?

Ask Custom Question

Capital Asset Pricing Model
The Capital Asset Pricing Model (CAPM) is a powerful analytical tool used for calculating the price of common stock. After reflecting on theory and application of the CAPM model and reviewing the prior work on the Constant Dividend Growth Model post a one paragraph response to the following questions.
Question 1 - What are the primary advantages and disadvantages of the Capital Asset Pricing Model (CAPM) compared with the Constant Dividend Growth Model for use in pricing common stock?
Question 2 - Can either or both of these two models be used to price the stock of Gamma Inc., a non-publicly traded company that does not pay dividends? Explain your answer.
Question 3 - Why is it that the financial models for calculating the price of a stock cannot be reliably used to make day to day investment decisions in the stock market?

Purchase this Solution
Solution Summary

This solution presents the advantages and disadvantages of the capital asset pricing model (CAPM) as compared to the constant dividend growth model (DGM). The solution also highlights the suitability of the models in calculating the stock price of non-publicly traded companies and discusses why the financial models for calculating the price of a stock cannot be reliably used to make day to day investment decisions in the stock market.

Solution Preview

Capital Asset Pricing Model
Question 1
Unlike the constant dividend growth model (DGM) which assumes that the dividend growth rate is known and stable, capital asset pricing model (CAPM) takes into account the level of systematic risk vis-à-vis the stock market as a whole. Secondly, CAPM eliminates unsystematic risk unlike DGM which assumes that stock price is hypersensitive and that the dividend growth rate cannot be higher than the cost of equity (Thomas & Gup, 2010). DGM ignores market conditions, thus making it easier to compare different companies whereas CAPM uses backward looking market returns which may be inaccurate in predicting future market returns. Additionally, CAPM's primary assumption of borrowing and lending at a risk-free rate makes the minimum required return inaccurate because ...

Purchase this Solution
Free BrainMass Quizzes
Transformational Leadership

This quiz covers the topic of transformational leadership. Specifically, this quiz covers the theories proposed by James MacGregor Burns and Bernard Bass. Students familiar with transformational leadership should easily be able to answer the questions detailed below.

Team Development Strategies

This quiz will assess your knowledge of team-building processes, learning styles, and leadership methods. Team development is essential to creating and maintaining high performing teams.

Organizational Leadership Quiz

This quiz prepares a person to do well when it comes to studying organizational leadership in their studies.

Basics of corporate finance

These questions will test you on your knowledge of finance.

Marketing Management Philosophies Quiz

A test on how well a student understands the basic assumptions of marketers on buyers that will form a basis of their marketing strategies.

View More Free Quizzes
Related BrainMass Solutions

  • The Dividend Discount Model and the CAPM

    There are a several varieties of the Dividend Discount Model including the zero growth model, the constant growth model, and the differential growth model.

  • Expected Rate of Return and Constant Growth Model

    514625 Expected Rate of Return and Constant Growth Model Use the CAPM to calculate the Expect Rate of Return = "r" Based on the assumptions that: Risk Free Rate = 3.50% Rf Market Return = 12.00% Rm

  • Stock Price Determination- Capital Asset Pricing Model

    This again may not hold true in future Determines the required rate of return using the Capital Asset Pricing Model (CAPM) and then using the constant growth dividend valuation model determines the intrinsic value of stock.

  • Growth Rate of Dividends (Constant Rate)

    The previous dividend was $2 (i.e., D0 = $2) and dividends are expected to grow at a constant rate. What is the growth rate for this stock? The growth rate can be found by using the dividend discount model.

  • Current Market Price of Toyota's Equity

    >> Calculations are attached in the excel file too. << ------------------ For finding the stock price of Toyota I am using CAPM model for finding the cost of equity and Constant growth model for finding the price.

  • Stock Valuations for Kummins Engone Company

    model Price = Dividend next year / (required return - growth rate of dividends) = $ 0.80 / (12.2%- 7%)= $15.38 Answer: Value of stock = $15.38 The solution calculates the value of stock using CAPM and dividend discount (constant

  • Stock Value Using CAPM and DDM

    575190 Stock Value Using CAPM and DDM Frazier Manufacturing paid a dividend last year of $2, which is expected to grow at a constant rate of 5%. Frazier has a beta of 1.3.

  • Dividend Growth, CAPM or APT

    The dividend growth model, which the expected dividend per share one year from now, the required rate of return for equity investor, and the growth rate in dividends, is the easiest model to use.

  • CAPM or DDM (div discount model). Which method is preferable for ROR on equity?

    41064 CAPM or DDM (div discount model). Which method is preferable for ROR on equity? My manager has asked me to calculate the required return on our company's equity, using either CAPM or DDM (Dividend Discount Model).

View More Related Solutions