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1. General Dividend Models The value of a share of stock is equal to the present value of an expected stream of future dividends. P 0 = Where P 0 = Present value of the stock price D i = Dividend for each year K e = Required rate of return (discount rate) Model assumes that the investor can determine the dividend for each period and the required rate of return. D 1 (1+K e ) 1 D 2 (1+K e ) 2 + D 3 (1+K e ) 3 + D n (1+K e ) n +. . +
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Constant Growth Model For extremely long time (infinite holding period) periods, this formula reduces to if following conditions are met. 1. g is constant 2. K e > g P 0 = + D 0 (1+g) 3 (1+K e ) 3 D 0 (1+g) 2 (1+K e ) 2 + D 0 (1+g) n (1+K e ) n + ... + D 0 (1+g) 1 (1+K e ) 1 P 0 = D 1 (K e - g)
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Required Return K e = Required rate of return R F = Risk-free rate b = Beta Coefficient K M = Expected return for common stocks in the market (K M - R F ) = Equity risk premium (ERP)
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