CAPM and Growth Model

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.

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