**CFA Level 1 - Equity Investments**

**Required Rate of Return**

This return can be derived from the CAPM model (R

_{cs}= R

_{f}+ B

_{cs}(R

_{market }- R

_{f})

**Expected Growth Rate**

**Dividend**

**Future Price**

**Example: Calculate the required inputs to be used in the DDM**

Newco's annual EPS last year was $1.00. The company maintained its annual dividend payout ratio of 40% and ROE of 16%. Newco's beta is 1.3. Given a risk-free rate of 4% and an expected return on the market of 18%, determine Newco's required rate of return, expected growth rate and next year's dividend and price?

**Answer:**

**Required rate of return**

R

_{Newco }= 4% + 1.3(18% - 4%) = 22.2%

**Expected growth rate**

Retention rate = (1 - payout rate) = (1 - 0.40) = 0.60

g

_{Newco}= (0.60)(0.16) = 0.096 or 9.6%

**Dividend**

D

_{1}= D

_{0}(1+g) = $1.00(1+.096) = $1.096

**P**

Future price

Future price

_{1}= D

_{1}/(r - g) = $1.096/(22.2% - 9.6%) = $8.70

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