Perpetuities and Annuities - Corporate Finance - Ivo Welch

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What is the cost of capital for a firm that pays a dividend yield of 5% per annum today, if its dividends are expected to grow at a rate of 3% per annum forever? 22/1
The Gordon Dividend Growth Model ◮ Using D for CF gives you the GDGM. ◮ Don’t trust the GDGM: Dividends can be rearranged. ◮ In fact, there is a fairly strong irrelevance proposition here. Given its underlying projects, it should not matter whether the firm pays out $1 or $10 in dividends. What it does not pay out in dividends today will make more hey (dividends) next year. Thus, expected rates of returns obtained from the Gordon model are highly suspect. ◮ An improvement on the simple GDGM is to work out the plowback ratio, which takes into account that reinvested cash should pay more dividends in the future. ◮ A better version, although without a fancy name, uses earnings instead of dividends. (There can be a similar irrelevance proposition for earnings as there is for dividends [firms can move earnings across periods], but it is not as easy/legal to shift earnings.) ◮ The GDGM is sometimes used to obtain an implied cost of capital, just as we did on the previous slide. Phrased differently, r = g + D/P is the expected rate of return embedded in the price of the firm today. A higher price today implies a lower implied cost of capital at which the firms can obtain capital from investors. 23/1
Page 1 and 2: Perpetuities and Annuities (Welch,
Page 3 and 4: General Questions ◮ Are there any
Page 5 and 6: Simple Perpetuities A perpetuity is
Page 7 and 8: ...in another language ◮ If you k
Page 9 and 10: What is the value of a promise to r
Page 11 and 12: What is the perpetuity formula if t
Page 13 and 14: Growing Perpetuities A growing perp
Page 15 and 16: How can a growing infinite sum be l
Page 17 and 18: What is the value of a firm that ju
Page 19 and 20: In 10 years, a firm will have annua
Page 21: What should be the share price of a
Page 25 and 26: Annuities An annuity is a financial
Page 27 and 28: Annuity Example: Mortgage Loan Here
Page 29 and 30: Omitted: Principal and Interest Dec
Page 31 and 32: What is the PV (or cost) of project
Page 33 and 34: What if you need to use the buildin
Page 35 and 36: Why is this EAC stuff in the annuit
Page 37 and 38: What are the payments to a 5% semi-
Page 39 and 40: Is the coupon rate of a bond equal
Page 41 and 42: An insurance company offers a retir
Page 43 and 44: The prevailing interest rate is 10%
Page 45 and 46: Assume that our firm has stopped gr
Page 47 and 48: An example drawn from an actual aut
Page 49 and 50: If you took out a loan from the ban
Page 51 and 52: Should you use perpetuities? How lo
Page 53: Omitted, but in the book ◮ Proof

Perpetuities and Annuities - Corporate Finance - Ivo Welch

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