Before General Bank was bought by National Bank, Abdul Basit was considering the purchase of General Bank's common stock. Given General Bank's recent merger with the Bank South, and talks of penetration into the Punjab market via a takeover of Punjab Bank, Abdul Basit felt General Bank would be a solid "buy and hold" as it continued to increase its market share through aggressive growth by acquisition.

While Abdul Basit was convinced he wanted to own General Bank, with all the price volatility surrounding the recent speculations, he was not sure if the price was above or below the stock's intrinsic value. He decided to derive the price of General Bank's common stock by using the Gordon Growth Model (Constant Growth Model).

To use the Gordon Growth Model, Abdul Basit had to first calculate General Bank's required rate of return on their common stock. The risk free rate, as proxied by the yield on a three month Treasury bill, was 6%. The return on the market, as proxied by the return on the KSE's 100, was 10%. General Bank had a beta of 1.75.

Past dividend payments also had to be known butAbdul Basit was not sure how far back into the future he should go to retrieve the dividend payment information, so he arbitrarily stopped in 2004 as before2004, General Bank seemed to have very different payout amounts. Not fully understanding the reasons behind these differences, Abdul Basit decided to consider the period for analysis only from 2004-2013. The dividend information that Abdul Basit recovered is shown below in Table 1.

Table 1

Year	Dividends (Rupees)
2013	2.200
2012	1.982
2011	1.785
2010	1.609
2009	1.449
2008	1.306
2007	1.176
2006	1.060
2005	0.955
2004	0.860

Questions:

A)Using the Capital Asset Pricing Model (CAPM), what was General Bank's required rate of return on common stock?

B)Consider the period from 2004-2013. Use the Gordon Growth Model to determine the price of General Bank's common stock today (i.e. 2014).

C)What effect does the stock's required rate of return have on the calculation of its stock price when using the Gordon Growth Model? (No calculation needed)

D)If you felt that General Bank's last year dividend of Rs.2.20 was going to be paid in that constant amount throughout the remainder of the company's life (i.e. zero growth), what would be the value of the stock today?

Based on the current year's expected dividend, what is the relationship between the present value of a dividend paid one year from now, a dividend paid ten years from now and a dividend paid one hundred years from now?

Answer rating: 100% (QA)

ANSWER A The Capital Asset Pricing Model CAPM describes the relationship between systematic risk and expected return for assets particularly stocks1 CAPM is widely used throughout finance for pricing ... View the full answer