Making investment is one of the most rational decisions which an investor has to take place because of the significant risks associated with the overall investment process. As a general principle, Investors/shareholders of ABC Ltd shall consider different benchmarks against which the investment decisions need to be made.
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Cost Of Equity Dividend Growth Model
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Two of the most important ones include the dividend Growth Model and Capital Asset Pricing Model. Following sections of the report will discuss both of these models in order to provide a conceptual understanding of the two. Dividend Growth Model Dividend Growth Model is relatively simple in use and is one of the earliest methods to be used for calculating the values of the stock. This model is based on following assumptions: 1. Dividends will grow at a steady and constant rate of growth.
Under this assumption, it is assumed that the dividends offered by the company will grow at a constant rate therefore any abnormal changes in the dividends paid out by the firm are not accounted for under normal circumstances in this model. 2. The equity of the company is considered as perpetuity i. e. company will continue to work in foreseeable future therefore the impacts of any financial distress are not accounted for in the model. Cost of equity or required rate of return under this method is computed by adding different risk premiums to the risk free rate of return.
Since the assumption is that investment shall at least earn a risk free rate of return offered by some government securities and if investors are willing to take on some more risk by investing into the stock markets than they should be compensated for various risks which they take
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