Question

You are given the following information on a security: Market price = $36 Annual Dividend =...

You are given the following information on a security: Market price = $36 Annual Dividend = $4 (Assume the dividend is constant and is paid forever) Discount rate = 10% Determine the intrinsic value of security and compare the intrinsic value to its market price.

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Answer #1

Intrinsic Value of the Stock

If the dividend is constant and is paid forever, then it is the case of perpetual dividend scenario. Under this perpetual payment of dividend, the Intrinsic value of calculated as follows

Intrinsic Value = Annual Dividend / Discount Rate

= $4.00 / 0.10

= $40 per share

COMPARISON

The Intrinsic Value of the stock is $40 per share whereas the Market Price of the stock only is $36 per share, Therefore, the Stock Price is “UNDER VALUED” in the market

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