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evalue of a share of common stock depends on the cash flows it is expected to provide, and those flows consist of the dividends the investor receives each year while blding the stock and the price the investor receives when the stock is sold. The final price includes the original price paid plus an expected capital gain. The actions of the larginal investor determine the equilibrium stock price. Market equilubrium occurs when the stock's price is its intrinsic value. If the stock market is easonably efficient, differences between the stock price and intrinsic value should not be very large and they should not persist for very long. When investing in common stocks, an investor's goal is to purchase stocks that are undervalued (the price is the stock's intrinsic value) and avoid stocks that are overvalued. The value of a stock today can be calculated as the present value of stream of drvidends: Valueofstock=P^0=(1+c4)1D1+(1+r4)2D1++(1+r4)mD=t=1(1+r4)1D4 This is the generalized stock valuation model. We will now look at 3 different stuations where we can adapt thes generalized model to each of these situations to determine a stock's intrinsic value: 1. Constant Growth Stocks; 2. Zero Growith Stocks; 3. Nonconstant Growth Stocks. Constant Growth Stocks: For many companies it is reasonable to predict that dividends wall grow at, a constant rate, so we can rewrite the generalized model as follows: This is known as the constant growth model or Gordon model, named atter Myron 3, Gordon who developed and popularized it. There are several condaions that mant exist before this equation can be used. First, the required rate of retum, fo. must be greater than the long-run growth nate, g. Second, the corntant growth model is rot approperate uniess a company's growth rate is expected to remain constant in the future. This condition almost never holds for furms, but it does exis for many Which of the following assumptions would cautse the constant growth stock valuation model to be invalid? a. The oromth rate is zero. b. The orowth rate is negative. Quantitative Problem 1t Hubbard industries just paid a cornmon dividend, Do, of $1.10. ft expects to grow at a constant rate of 3% per yeae, if investors require a 12%. return on equity, what is the current price of Hubbard's common stock? Do not round intermediate calculations. Round your answer to the nearest cent. 5 (3) per share The constant growth model is sufficiently general to handle the case of a zero growth stock, where the dividend is expected to remain constant over time. In this situation, the equation is: P^0=4D Note that this is the same equation developed in Chapter 5 to value a perpetuicy, and it is the same equation used to value a perpetial preferred stock that entitles its owners to regular, fored dividend payments in perpetuity. The valuation equation is simply the current dividend drided by the required rate of return. Quantitative Problem 2: Cailysle Corporation has perpetual preferred stock outstandieg that pays a constant annual dividend of $1.50 at the end of esch yeac. II investon require an 6% teturn on the preferred stock, what is the price of the frm's perpefual pireferred stock? found your answer to the nearest cent, 5 (3) per share Nhancotatant Growet stocks- for many companies, it is not appropriate to assume that dividends will grow at a constant rate. Most firms go through life cycles where they experience different growth rates during different parts of the cycle. For valuing these firms, the generalized valuation and the constant growth equations are combined to airive at the nonconstant growth vahistin equation: P^0=(1+r4)2D1+(1+r1)2D3++(1+re)2Dx+(1+t4)nP^x Basically, this equation calculates the present value of deridends recelwed during the nonconstant growth period and the present value of the Mock's herison value, which is the value at the horiron date of all dividends axpected theresiter. gronth modet (allowing for nonconstant growh). what should be the poice of the company's stock today (December j1, 2019) Do not round inteimedate calcufations. Hound your answer to the nearest cent. 5. (3) per share