# 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

We found the Beta of AB 217 Corp = 0.85

SO

CAPM = Rf + Beta(RM - Rf) r = Question 1

This will be the "r" value that is used in the CGM.

Estimate the value of "g" ... the constant growth rate ..

Calculate the Dividend Growth Rate of AB 217 for Constant Growth Model (CGM)

We use actuall AB 217 history

PV ($1.20) Dividend paid 6 years ago. Negative so Excel can do the math

FV $1.55 Dividend paid this year = Do)

n 6

PMT 0

Rate This will be the Dividend Growth Rate ... = g Question 2

Constant Growth Model

Estimate the value of AB 217 stock using the CGM

D1 = Question 3

Po = #DIV/0! Question 4

© BrainMass Inc. brainmass.com October 25, 2018, 7:46 am ad1c9bdddfhttps://brainmass.com/statistics/central-tendency/expected-rate-return-constant-growth-model-514625

#### Solution Preview

1. CAPM = r = Rf + Beta(Rm-Rf) = 0.035 + 0.85(0.12-0.035) = ...

#### Solution Summary

The expected rate of return and constant growth models are examined. The risk free rate are provided.

Portfolio Expected Rate of Return and Beta and the Constant Dividend Growth Model

Monica Dubois, an ABC investment advisor, has a new client, Mr. Jack Klein. Mr. Klein is a conservative investor who is interested in a required rate of return of 10% on his stock investments while assuming lower market risk. You are asked to help Monica make a suitable portfolio recommendation backed by risk-return calculations. The 3 possible stock choices for Mr. Klein and their respective betas are as follows:

(see attached file for data)

Part I

Determine the expected returns and beta for a portfolio consisting of one third of Mr. Klein's funds in each stock.

Part II

Assume the following:

- Each ABC stock pays current dividends of $1.50 annually with 6% expected annual increases. The current market stock price for ABC is $30 per share.

- Each XYZ stock pays current dividends of $1.75 annually with 6% expected annual increases. The current market stock price for XYZ is $27 per share.

- Each WHY stock pays current dividends of $2.25 annually with 7% expected annual increases. Current market stock price for WHY is $35 per share.

Complete the following for this assignment:

- Using the constant dividend growth model, determine whether ABC and WHY are over- or undervalued.

- For what types of companies is the constant growth model an appropriate analysis tool?

- What are the limitations of the constant growth model?