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Learning Outcome:
After doing this activity, students will be able to understand the relationship of components of Gordon Growth model and how the relationship between these components can affect current stock price.
GDB Statement:
Gordon growth model also referred to as constant growth model or dividend discount model in finance literature has long been used for common and preferred stock valuation.
P_{o} = D_{1}/(r – g) = D_{o}*(1+g)/(r – g)
This model states that current stock price (P_{o}) of any company can be ascertained by a relationship between expected growth rate of dividends (g) and investor’s required rate of return (r). Being an investor, this should be a major concern that how these two significant factors act as determinants of stock price.
The two graphs show current price of a stock (P_{o}) determined by using different values of (r) and (g) in four different cases:
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Fin622 gdb idea
Q1.Under the Gordon Growth Model, a stock becomes more valuable when its dividend increases, the investor's required rate of return decreases, or the expected dividend growth rate increases. The Gordon Growth Model also implies that a stock price grows at the same rate as dividends.
After doing this activity, students will be able to understand the relationship of components of Gordon Growth model and how the relationship between these components can affect current stock price.
GDB Statement:
Gordon growth model also referred to as constant growth model or dividend discount model in finance literature has long been used for common and preferred stock valuation.
Po = D1/(r – g) = Do*(1+g)/(r – g)
This model states that current stock price (Po) of any company can be ascertained by a relationship between expected growth rate of dividends (g) and investor’s required rate of return (r). Being an investor, this should be a major concern that how these two significant factors act as determinants of stock price.
The two graphs show current price of a stock (Po) determined by using different values of (r) and (g) in four different cases:
Requirement:
Describe the relationship between investor’s required rate of return and growth rate.
How this relationship (between investor’s required rate of return and growth rate) explains the changes in stock price? Provide logical reasoning.
Special Note:
Students are highly advised to take into account Gordon Growth formula while observing graphical representation of model to better understand the requirement of GDB.
Your answer should be to the point and must satisfy the question requirement.
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Note:
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Note related to load shedding: Please be proactive
Dear students
As you know that Pre Mid-Term semester activities have started and load shedding problem is also prevailing in our country. Keeping in view the fact, you all are advised to post your activities as early as possible without waiting for the due date. For your convenience; activity schedule has already been uploaded on VULMS for the current semester, therefore no excuse will be entertained after due date of assignments or GDBs.
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Fin622 gdb idea
Q1.Under the Gordon Growth Model, a stock becomes more valuable when its dividend increases, the investor's required rate of return decreases, or the expected dividend growth rate increases. The Gordon Growth Model also implies that a stock price grows at the same rate as dividends.
+ ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! thanks for sharing
Answer:
In graph 1, required rate of return (r) and expected growth rate of dividend (g) have a direct relationship i.e. with the decrease in ‘g’ there is a decrease in ‘r’ as well. Whereas in graph 2, there is an inverse relationship between ‘r’ and ‘g’ i.e. with an increase in growth rate the expected rate of return decreases.
In graph 1,
Due to bearish trend prices of stock in all 4 cases are declining.
The prices are patterned in a downward trend So, is the growth rate (g) and required rate of return (r). Indicating support.
According to the assumption of chartists, investors focus mainly on the terminal prices. So, with falling rates the prices relatably falls down.
In graph 2,
Because of a bullish trend prices of stock in all 4 cases are escalating.
The prices are ceiling upward because of the increasing growth rate (g) and decreasing required rate of return (r). Indicating resistance.
According to Gordon Growth Model a stock is considered valuable when it’s required rate of return (r) decreases or the expected growth rate (g) increases. So logically it is true that P◦ is and will grow.
Thank you!
GDB solution FIN622... Answer: In graph 1, required rate of return (r) and expected growth rate of dividend (g) have a direct relationship i.e. with the decrease in ‘g’ there is a decrease in ‘r’ as well. Whereas in graph 2, there is an inverse relationship between ‘r’ and ‘g’ i.e. with an increase in growth rate the expected rate of return decreases. In graph 1, Due to bearish trend prices of stock in all 4 cases are declining. The prices are patterned in a downward trend So, is the growth rate (g) and required rate of return (r). Indicating support. According to the assumption of chartists, investors focus mainly on the terminal prices. So, with falling rates the prices relatably falls down. In graph 2, Because of a bullish trend prices of stock in all 4 cases are escalating. The prices are ceiling upward because of the increasing growth rate (g) and decreasing required rate of return (r). Indicating resistance. According to Gordon Growth Model a stock is considered valuable when it’s required rate of return (r) decreases or the expected growth rate (g) increases. So logically it is true that P◦ is and will grow. Thank you!
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