# Finance 3000 test 3- assignment 9/10

 constant growth model dividends will grow at a constant rate to infinity. THere is no terminal year using this model dividend growth rate must be less than the required return.IF it were equal the denominator would be zero and you cant divide by zero.IF it were greater than, the denominator would be zero and therefore the stock price calculated would be negative. expected return sum of dividend yield and growth rate, so the required rate of return will be higher than the growth rate. otherwise the company would grow more than the market and eventually become larger than the market which is impossible. therefore the growth rate is lower than the required return rate. stock intrinsic value if a stock is in equilibrium, its intrinsic value equals its current stock price. Expected Dividend Yield equals its expected dividend one year , divided by the current stock price capital gains yield the expected change in price over the next year, divided by its current stock price required rate of return expected dividend yield plus expected capital gains yield an increase in dividends if a company increases its dividends, it is retaining less earnings for future investments, therefore the growth rate might decrease. constant growth stock valuation model requires that a firms dividends follow a stable and predictable pattern. companies growth rate the required rate of return must be higher than the long run growth rate for the constant growth valuation model to be meaningful capital gains yield a stock that the investor already owns has a direct relationship on the firms expected future stocks price constant growth valuation facts do not use this formula unless the companies growth rate is expected to remain constant in the future.2.rapidly growing start up companies can be expected to pay dividends at some point in the future3. the formula can handle the case of a xero growth stock where the dividend is expected to remain constant the whole time, it just reduces everything. growth rate in earnings and dividends g=(1-Payout ratio)* (net income/ common equity){g=(1-payout ratio)* Return on Equity} relationship between earnings and dividends facts long run growth occurs because the company retains earnings to reinvest them in the business, therefore the higher the percentage of earnings retained, the higher the growth rate.2. growth in dividends requires growth in earnings, not the other way around required return on stock risk free return+ ( Market risk premium* Stocks beta) horizon date is at year one where the constant growth rate begins and the nonconstant growth rate ends FCF is the cash flow available to the firm’s bond and stock investors after all required investments have been made calculated FCF with capital expenditures FCF=EBIT(1-T)-Net capital expenditures- NOWC(change in) calculated FCF with gross capital expenditures FCF=EBIT(1-T)-(Gross capital expenditures-Depreciation expense)-NOWC(change in) total firm value total firm value=FCF1/(WACC-g) MV of common equity MV of common equity=TOtal firm value-MV of debt-MV of Preferred Stock intrinsic value per share intrinsic value per share=MV of common equity/ number of common shares WACC equation components rd=before tax cost of debtrp= cost of preffered stockrs= cost of common equity raised by retained earningsre= cost of common equity raised by issuing common stock weight of preffered stock (wp) wp=preffered stock/ (Debt+ Preffered stock+ Equity) weight on debt(wd) wd= debt/(debt+ preffered stock+ equity) True a company needs to adjust its cost of debt for taxes, because most interest payments are tax deductible issuing preffered stock dividends does not result in a tax shelter because dividends are paid out on an after tax basis. This is why you don’t have to mulitiply preffered stock by 1-tax rate in the WACC equation. debt financing vs retained earnings debt financing will typically have a lower cost than that from retained earnings despite the fact that funds from retained earnings are readily available to the firm because there is still a opportunity cost from retained earnings. equity vs debt financing equity typically has more risk than debt financing. COnsequently the cost of raising funds for retained earnings excceeds the cost of raising funds through debt financing interest payments on debt are paid out of a companies pretax earnings a higher tax rate results in a lower after tax cost of debt. therefore, a lower after tax cost of debt will reduce a companies WACC the before tax cost of debt is the interest rate that the firm pays on any new debt financing after tax cost of debt equation after tax cost of debt= interest rate on new debt- Tax savingsAfter tax cost of debt={ rdX(1-T)} bonds annual coupon payment annual coupon= bonds face value X annual coupon rate YTM use newly calculated annual coupon pymt, then plug in -PV, the N, and the FV to calulate I.Once calulated I (bonds before tax cost of debt)– and enter as the rd for the after tax cost of debt equation. preferred stock characteristics debt usually has a specified maturity date but equity doesn’t have one. calculate cost of preferred stock(Rps) rps= Dp/Vp ( dividend payment / value at par payment) characteristics of Preferred stock debt: has no par value, or face valueequity: no tax adjustments are made when calculating the cost of preferred stock factors that the firm cannot control 1. capital structure2. the performance of index funds like the S&P 5003. the firms dividend ratio4. the general level of stock prices 5. inflation rate6. tax rate
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