CAPM and Growth Model — OpenTuition Forums

DDreamerSK9y ago

In the last lecture on the above topic, we use CAPM and then the growth model to calculate market value. My question...if everything else stays the same then an increase in required return would result in a decrease in in MV using the growth model. Is this correct? I assume that everything else does not stay the same and that is why an increase in required return will usually result in an increase in MV. Is it because dividends increase when required return increases?

John MoffatTutor9y ago#1

Whether we are using CAPM or not to establish the required return, then an increase in the shareholders required return will always lead to a reduction in the market value of the equity (unless, of course, the company increases the dividends). As I explain in the lectures, the market value is always the present value of future expected dividends discounted at the shareholders required return (which is all that the growth model formula is doing), and discounting at a higher rate will reduce the market value. This is what happens in real life - if general interest rates go up, then investors will only be prepared to pay less for shares (otherwise they would be better putting their money in the bank and earning more interest!), and vice versa - if interest rates go down then share prices increase.

DDreamerSK9y ago#2

Thank you.

John MoffatTutor9y ago#3

You are welcome :-)