Unit 6: Discussion Questions 2 No unread replies. No replies. Each unit you will find discussion questions related to the chapters covered. Please answer one of the assigned questions from each assigned chapter. Each unit you will find a “Discussion” thread to be used to post your answers to the chapter discussion questions entitled Online Discussion Questions for Unit #. Please select a question, develop a complete answer, and post it in the thread. You should also respond to a fellow student’s answered question by reinforcing their work or adding additional information or ask for clarification in regards to their answer. Chapter 13: How is the intrinsic value of a firm determined using the constant growth model? How is the intrinsic value of a firm determined using the constant dividend discount model? How are Price Earnings Ratios using in stock analysis? How is the earnings multiplier used to forecast stocks or the stock market?

Intrinsic value by constant growth model

Intrinsic value is defined as the underlying value of a firm that is usually found via the fundamental analysis. The strongest investor, Warren Buffett has managed to select the stocks that have the greatest intrinsic value than the existing value in the market. The intrinsic value is often determined by discounting a group of future cash flow and the expected income to be given by the stock or the firm in return for its current value (Lee, Myers & Swaminathan, 2009). In symbol terms, the current value stands for the present value or just cash flows in the near future.

The constant growth model is used to measure the intrinsic value. This model usually assumes that the firm facing a constant growth rate. It is normally utilized by big organizations that have both consistent dividends and earnings. However, this method can also be used by small as well as medium size companies whose dividends and earnings are growing steadily. The formula that is used in this model is:

Price of Stock=D1/ (k-g)

Where:

G=dividends growth rate

K=needed return rate

D1=Coming year dividends

Just like any other model, the generated output is as better as the factors’ quality that is heading into the computations. Both earnings and dividends information are largely present, but the needed return rate, as well as dividends rate of growth, need assumptions to be concluded (Sorensen& Williamson, 2008). The formula adopted in determining the possible return rate is:

Return rate needed=Rate of free risk+ (equity beta*premium market risk)

 

References

Lee, C., Myers, J., & Swaminathan, B. (2009). What is the Intrinsic Value of the Dow?. The

Journal of Finance54(5), 1693-1741.

Sorensen, E. H., & Williamson, D. A. (2008). Some evidence on the value of dividend discount

Models. Financial Analysts Journal41(6), 60-69.

 

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