QUESTION

The Capital Asset Pricing Model (CAPM) is a linear model that can be used to estimate a company’s cost of equity and d

Category: Business
Subject: Finance
Due Date: 06/26/2014
Question Asked: 2014-06-21 20:41:07

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The Capital Asset Pricing Model (CAPM) is a linear model that can be used to estimate a company’s cost of equity and determine a stock’s required rate of return. The required rate of return is one input into the Dividend Discount Model, a model used to determine the value of a company’s common stock. There are a several varieties of the Dividend Discount Model including the zero growth model, the constant growth model, and the differential growth model. An analyst needs to use his or her best judgment to determine which model variety should be used to value a company’s common stock. For example, if the analysts forecasts that the company’s dividends will grow at a fixed rate of 5% per year forever, then the constant growth model should be used. If, on the other hand, the analyst forecasts that the company’s dividends will grow at a 15% growth rate for the next three years and then growth at a constant rate of 7% per year, then the differential growth model should be used. As you can see, there’s a lot of estimation involved in applying the Dividend Discount Model. Because of this situation, it’s useful to conduct a sensitivity analysis.

References:

Penman, S.H. (1997, November 5). A synthesis of equity valuation techniques and the terminal value calculation for the dividend discount model. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=38720

Womack, K.L, & Zhang, Y. (2003, December 19). Understanding risk and return, the capm, and the fama-french three-factor model. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=481881

Required:

Below are some questions for discussion.

Please apply the Dividend Discount Model to the common stock of a publicly-traded company of your choosing. Based off your results from the model, state whether you believe that the company’s common stock is currently overvalued, overvalued, or fully valued. Please be sure to state your assumptions and justify your results.
Beta is one of the inputs into the CAPM. How’s a stock’s beta determined? Is beta a good measure of risk? Why or why not?
What are some competing models to the CAPM to determine a company’s cost of equity? Compare and contrast them to the CAPM.

Additional Requirements

Min Pages: 1
Level of Detail: Only answer needed
Other Requirements: The Capital Asset Pricing Model (CAPM) is a linear model that can be used to estimate a company’s cost of equity and determine a stock’s required rate of return. The required rate of return is one input into the Dividend Discount Model, a model used to determine the value of a company’s common stock. There are a several varieties of the Dividend Discount Model including the zero growth model, the constant growth model, and the differential growth model. An analyst needs to use his or her best judgment to determine which model variety should be used to value a company’s common stock. For example, if the analysts forecasts that the company’s dividends will grow at a fixed rate of 5% per year forever, then the constant growth model should be used. If, on the other hand, the analyst forecasts that the company’s dividends will grow at a 15% growth rate for the next three years and then growth at a constant rate of 7% per year, then the differential growth model should be used. As you can see, there’s a lot of estimation involved in applying the Dividend Discount Model. Because of this situation, it’s useful to conduct a sensitivity analysis.

References:

Penman, S.H. (1997, November 5). A synthesis of equity valuation techniques and the terminal value calculation for the dividend discount model. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=38720

Womack, K.L, & Zhang, Y. (2003, December 19). Understanding risk and return, the capm, and the fama-french three-factor model. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=481881

Required:

Below are some questions for discussion.

Please apply the Dividend Discount Model to the common stock of a publicly-traded company of your choosing. Based off your results from the model, state whether you believe that the company’s common stock is currently overvalued, overvalued, or fully valued. Please be sure to state your assumptions and justify your results.
Beta is one of the inputs into the CAPM. How’s a stock’s beta determined? Is beta a good measure of risk? Why or why not?
What are some competing models to the CAPM to determine a company’s cost of equity? Compare and contrast them to the CAPM.


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Posted on 2014-06-25 04:48:58

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