Chip, not so heartbroken, tries to woo a new love with his great investment acumen. Chip recommends she buy XYZ Inc. at $60. The stock pays a $2.40 dividend which (like its per share earnings) is expected to grow annually at 8 percent. If she wants to earn 12 percent on her funds, is this a good buy?
| we have to compute the price today using dividend discount model | |||||||||
| as per dividend discount model price today = expected dividend/(required rate - growth rate) | |||||||||
| epxected dividend = | =2.4*(1+8%) | 2.5920 | |||||||
| Growth rate = | 8% | ||||||||
| required rate = | 12% | ||||||||
| therefore price today = | =2.5920/(12%-8%) | ||||||||
| intrinsic value | 64.80 | ||||||||
| current price = | 60 | ||||||||
| Since the current price is lower than intrinsic value therefore its good buy | |||||||||
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