# Accounting Info. 3.docx

## Accounting 225 with Adams at University of Washington - Seattle Campus *

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- Accounting Info. 3.docx

Duke Power Example 5.2% dividend yield; 4.1% rate of dividend growth projected; seems to imply a 9.3% required rate-of-return on equity for Duke Power. Danger: your estimate of the required rate-of-return is only as good as your estimate of dividend growth. Do not use the simple constant-growth formula to test whether the market is correct in its assessment of stock value. If your estimate is different, it is more likely that you are wrong than that the market is wrong. Earnings Suppose a business is earning $10 a share (expected to continue forever), the market capitalization rate is 8%, and the firm pays out some of its earnings as dividends and invests the rest in projects that yield the market capitalization rate--and suppose we know that the company is going to be able to continue this policy forever. What is its price? You might say that you need to know the dividend in order to calculate its price. Actually, you don't. Suppose it pays a dividend of zero. Then next year it is earning $10.80--and if it then starts paying out all of its earnings as dividends, it will be worth (with dividend) $135+$10.80=$145.80 per share. $145.80 per share next year has a P.V. of $135 this year--the with dividend price of the stock. Suppose it pays a dividend of $10 this year. Then its with-dividend value is the same $135. Only if the firm has the opportunity to invest at above-market rates of return (because of market position, monopoly power, some special edge, whatever) does its dividend policy matter. P(0) = EarningsPerShare/r + PresentValueofGrowthOpportunities or EPS/P(0) =r{1- PVGO/P(0)} If EPS/P(0) is less than r, then the firm had better have super-market return investment opportunities... Fledgling Electronics: Market capitalization rate r of 15% per year $5 first-year dividend Thereafter dividend grows by 10% per year Market price of $100 a share

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