Question

Common Stock Valuation, Pt. I - Discussion #1

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Dividend discount model - ex. #1
(Note: This is similar to a former exam question.)

a. Using the dividend discount model, what is the current market value of a stock (i.e., P0) that has a par value of $0.10 per share, a dividend growth rate of 5%, and an expected dividend of $ .80 per share at the end of the year, assuming your required rate of return for the stock is 12.5%? Assume the market is at equilibrium.

b. (Review) The charter authorizes 35 million shares. Treasury stock is 3 million shares, and issued stock is 12 million shares. What is the company's market capitalization, assuming the market is at equilibrium?

Answer 1

a) P0 = D1 / (Ke - g) = $0.80 / (0.125 - 0.05) = $10.666666666 or $10.67

where, D1 = expected dividend, Ke = required return, g = growth rate

b) Market capitalization = Issued stock x market price per share = 12,000,000 x $10.67 = 128,040,000 or 128.04 million

Note : Treasury stock are the stock that company has repurchased from the market and are not included while calculating earnings per share or market capitalization. We only use the current issued and outstanding shares while calculating market capitalization. The language of the question is not clear on the outstanding shares part. I assumed that the issued shares are issued and outstanding. In case that is not the case and you get the answer as wrong, try deducting treasury stock from issued stock and then multiply with the share price.