Week 9 - Equity models

Capital Asset Pricing Model (CAPM)

Represents the relationship between risk and expected return on an asset

CAPM Formula

Eri = Rf + β(E(rm) - Rf)

CAPM Formula in words

Expected return = risk free rate + beta x market premium - risk free rate

Dividend Discount Model

Assumes a constant, non-growing dividend stream

Dividend Discount model

Price today = Dividend ÷ discount rate

What does it mean when i say CAPM is a single factor model

Only one risk - market risk

What does beta measure

Measures sensitivity of a stock’s return to the overall market returns

Book value

Value of firm in regards to its internal financial statements

Book value formula

Total assets - Total liabilities

Liquidation value

Value of a firm if it sold all it’s assets on an open market

Forced liquidation 

Assets are sold at a discount quickly, so it’s lower value

Orderly Liquidation

Assets sold in a planned, gradual manner to maximise value

Gordons growth model

Assumes dividends grow at a constant rate

In gordons growth model, Dividends grow

at a rate that is less than required rate of return

Gordons growth model formula

Price today = Dividend ÷ Discount rate - growth rate

Price/Earnings ratio

Tells investors how much a company is worth

Price/Earnings ratio is

how much investors are willing to pay per $1 of earnings

Price/Earnings formula

Stock price ÷ company earnings per share

High P/E

Investors estimate high growth so they pay more than company is earning

Low P/E

Company has low growth - may be mature, stable or undervalued