Apply the Dividend Discount Model (DDM) to analyze the effect of the interest rate on the valuation of shares. We must also make connections to reality, but be aware then that the model is a rough simplification of reality and that the specific figures in the task are made up. I would still like to emphasize that the general points we will make are still the highest relevant to the valuation of shares and the current situation we are in today. This is why that all models for how to value stocks are to some extent about discounting a future cash flow and is affected by interest rates. A small economy in an unknown place in the world has since the beginning of time (year 0) experienced 24 years of declining interest rates and they went from paying about 6% interest on 10-year government securities to to pay as little as 0% interest on 10-year government securities today. The interest rate has fallen gradually by 0.25% every year. Assume that the company Mark AB has had a risk premium that has been stable at 6% throughout period and that a dividend of SEK 10 per share was distributed in year 1. The dividend has since grown accordingly expectation of 2% per year, which is also the growth rate expected for all time to come. Assume that the interest rate on 10-year government securities is equal to the risk-free interest rate and calculate the required rate of return to ???? = ???????? + risk premium. i) Valuate Mark AB’s share for each year from year 0 to year 24 using DDM and plot the value of the stock in a chart. Suppose one at each time has assumed that the prevailing interest rate will be forever. ii) Evaluate Mark ABs under two hypothetical scenarios where the interest rate is instead in one the case is still at 2% throughout the period and in the second case is still at 6% throughout period. Plot the values according to the two different scenarios in the same diagram as above. a. Comment on the graph you produced according to i) and ii) in general and also specifically discuss the development of the share price given the different interest rates. is the difference in the share price’s percentage growth given the falling interest rate compared to if the interest rate had remained at 6%? Also connect developments in the Swedish stock market over the past 24 years.
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