Elgar Green Inc Business Operating - Essay Example

Download file to see previous pages The details mentioned in the data require that the long-run rate of return must be calculated using the formula of present value of dividend using the Dividend Discount Model. In the above-provided case since the value of the price was already provided, the formula for such payments has been manipulated and the rate of return has been evaluated. The formula for DDM for the current price of shares is rearranged for the calculation of rate of the return. Hence, the expected long-run rate of return is 8.67%. This means that when the company is paying 60 percent of its earnings as dividends to shareholders and investors are pricing the share at USD.150, the required rate of return in the long term is 6.67%.

This percentage assumes that the price is based on incorporating all information about the company. The formula can be summarized as the ratio of the cash flows of dividends received in future periods by the net difference between the discount rate and the growth rate. This formula is developed on the concept that the current price of stocks is a series of payments that grow as dividends perpetually at a constant rate. The formula assumes that the payments of dividends are received for an infinite period at a constant growth rate. For the calculation of Present value, the discount rate used for the calculation must be higher than the growth rate.

PART B

The dividend discount model assumes that the price of stocks follows constant growth indefinitely across the life of the company (McLaney, 2009). However, on actual grounds, the growth of the company varies from time to time. For instance, in the above case, The Company aims to expand and, therefore, has changed the dividend policy across for five years (Ross, Westerfield, and Jordan, 2009).

In such a case, a stage dividend discount model is used to evaluate the price of the stock inthe current year. In such a system of two staged growth, the price of stocks is measured by calculating the present value of dividend streams by discounting it with a required rate of return. For the second staged growth, the price of a stock is calculated for the year in which growth has changed and is then discounted to the current year (Gitman, 2003). In the final stage, the present values of two staged dividend growth are combined. The above table determines that to get base year information, it is assumed that the earning of the company for year one remains the same as it is provided in the case. ...Download file to see next pages Read More