If g > k s , the constant growth formula leads to a negative stock price, which does not make sense.
The constant growth model can only be used if:
k s > g
g is expected to be constant forever
6.
If k RF = 7%, k M = 12%, and β = 1.2, what is the required rate of return on the firm’s stock?
Use the SML to calculate the required rate of return (k s ):
k s = k RF + (k M – k RF ) β
= 7% + (12% - 7%)1.2
= 13%
7.
If D 0 = $2 and g is a constant 6%, find the expected dividend stream for the next 3 years, and their PVs. 1.8761 1.7599 D 0 = 2.00 1.6509 k s = 13% g = 6% 0 1 2.247 2 2.382 3 2.12
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