The Dividend Growth Model and Capital Asset Pricing Model Assignment

The Dividend Growth Model and Capital Asset Pricing Model - Assignment Example This paper illustrates that the CAPM model can be used to calculate the possibilities of the growth of investment. CAPM takes into account the risk involved in the marketplace as well as the risk bored by the company that issued the stock. Dividend-growth model is a model that is used in the valuation of a company’s stock. Essentially, the Dividend growth model is a model of stock valuation that primarily deals with the dividends and their consequent growth discounted to present day. The models are divided into two as; Gordon growth model commonly referred to as the dividend discount model is a method that is used to calculate the intrinsic value of stocks. However, the model is based on the assumption that the dividend growth rate is constant. The formula employed by this model is as follows; Multi-stage dividend discount model is a dividend growth model that can take any pattern of the future expected dividends; that is to mean that dividends are not expected to grow at a co nstant rate. The investor is therefore expected to evaluate dividends separately for each year while putting into consideration each year’s expected dividend growth rate. This model is given by the formula; Capital asset pricing model or CAPM is a model that specifies the relationship between risk and required rate of return on assets held by an investor in a well-diversified portfolio. The required rate of return obtained using the CAPM formula is used as the cost of equity of the company. The model has several basic assumptions; first, investors are assumed to be rational in the sense that they choose among alternative portfolios on the basis of the expected return and standard deviation of the portfolio held. Secondly, CAPM model also assumes that investors have homogeneous expectations with regard to asset return.