Estimating requity using the DDM:Example: A firm’s shares are trading for $45 per share. The firm is expected to pay a $2 per share dividend at the end of the year. What is its expected return on equity assuming a 9% constant growth rate?
? Expected returns on preferred stock
A preferred stock that pays a fixed annual dividend is no more than a simple perpetuity.
WACC Pitfalls
The WACC is appropriate only for projects that have the same risk as the firm’s existing business.
? Upward/Downward Adjustments
? Altering Capital Structure
? Two costs of debt finance: Explicit and Implicit
When You Can and Can’t Use WACC ? WACC is the company?s benchmark discount rate. Investment projects under consideration with higher or lower risk than average business risk should be discounted with rates above or below the WACC.
? The WACC is the rate of return that the business must expect to earn on its average-risk investments in order to provide the opportunity rate of return to all its investors.