BUSINESS FINANCE

CLASS ACTIVITY 5

Ali Muhammad
F2018054037

Submitted To;
Sir Tahseen Mohsin
What do you mean by the following;
Constant Growth Model: The constant growth model, is a way of valuing stock. It assumes that
a company's dividends are going to continue to rise at a constant growth rate indefinitely. You
can use that assumption to figure out what a fair price is to pay for the stock today based on those
future dividend payments.
P = D/(r-g)

No Growth Model: The zero growth DDM model assumes that dividends have a zero-growth
rate. In other words, all dividends paid by a stock remain the same. The formula used for
estimating value of such stocks is essentially the formula for valuing the perpetuity.
P= Dividend/r

Non-constant Growth Model: The primary difference between a constant and non-constant
growth dividend model is the perspective on future growth. A constant growth model assumes
that growth rates will stay largely identical in the future to where they are now, while a non-
constant growth model believes that these rates can change at any point.
r = D/P + g

Develop the scenario for each type of above models and calculate the value of any stock of
your choice for at least FIVE years.
Constant Growth Model:
If the dividend at the time of investment=Rs.2 and the growth rate is 4%. Calculate the intrinsic
present value of stock and its’ values for FIVE years considering return on stock is 10%.
Given,
D0= 2 (dividend at the time of stock purchase, g=4% (Expected growth rate of dividend),
Rs=10% (Expected return on stock)
What is to find P0, P1, P2, P3, P4, P5
Solution:
D0= 2 (Dividend at the time of stock purchase)
D1= D0(1 + g) =2(1 + 0.04) =2.08
D2= D1(1 + g) = D0(1 + g) (1 + g) = D0(1 + g)2=2 (1 + 0.04)2=2.16
D3= D2(1 + g) = D0(1 + g)2(1 + g) = D0(1 + g)3=2 (1 + 0.04)3=2.25
D4= D3(1 + g) = D0(1 + g)3(1 + g) = D0(1 + g)4=2 (1 + 0.04)4=2.34
D5= D4(1 + g) = D0(1 + g)4(1 + g) = D0(1 + g)5=2(1 + 0.04)5=2.43
D6= D5(1+g) = D0(1+g)5(1+g) = D0(1+g)6=2(1+0.04)6= 2.53
Values of stocks (P0) at the time of purchase:

P0= D0(1 + g)/ (Rs – g) =D1/ (Rs – g) =2.08/ (0.10 – 0.04) =2.08/0.06=34.67

Values of stocks (P1) after one year:

P1= D0(1 + g)2/ (Rs – g) =D2/ (Rs – g) =2.16/ (0.10 – 0.04) =2.16/0.06=36.00

Values of stocks (P2) after two year:

P2= D0(1 + g)3/ (Rs – g) =D3/ (Rs – g) =2.25/ (0.10 – 0.04) =2.25/0.06=37.50

Values of stocks (P3) after three year:

P3= D0(1 + g)4/ (Rs – g) =D4/ (Rs – g) =2.34/ (0.10 – 0.04) =2.34/0.06=39.00

Values of stocks (P1) after four year:

P4= D0(1 + g)5/ (Rs – g) =D5/ (Rs – g) =2.43/ (0.10 – 0.04) =2.43/0.06=40.50

Values of Stocks (P1) after five years:

P5=D0(1+g)6/ (Rs-g) =D5/(Rs-g) = 2.53/ (0.10-0.04) =2.53/0.06=42.16

No Growth Model:

D0=2=PMT (Equal series of dividend payments), g=0 (no growth in dividend amount), Rs=10% (Expected
return on stock)

Intrinsic Present value of stock

P0=PMT/Rs = 2/0.10= 20

Non-Constant Growth Model:

D0= 2 (dividend at the time of stock purchase, g1=4% (Expected growth rate of dividend for THREE
years), g2=9% (thereafter dividend growth changes from 4% to 9%), rs=10% (Expected return on stock)

D1= D0(1 + g1) =2(1 + 0.04) =2.08

D2= D1(1 + g1) = D0(1 + g1) (1 + g1) = D0(1 + g1)2=2(1 + 0.04)2=2.16

D3= D2(1 + g1) = D0(1 + g1)2(1 + g1) = D0(1 + g1)3=2(1 + 0.04)3=2.25

D4= D3(1 + g2) = 2.25(1 + 0.09) =2.45

Calculate the discount values of dividend for THREE years:

=D1/ (1 + rs)1 + D2/ (1 + rs)2 + D3/ (1 + rs)3

=2.08/ (1 + 0.10)1 + 2.16/ (1 + 0.10)2 + 2.25/ (1 + 0.10)3

=1.89 + 1.785 + 1.69 = 5.365

Calculate the value for FIFTH year

= D3(1 + g2)/ (rs – g2) =2.25(1 + 0.09)/ (0.10 – 0.09) = 2.45/0.01=245

Discount of P5

P3=245/ (1 + 0.10)3=184.07

Present value of stock

P0=5.365 + 184.07=189.44