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Moon Inc. paid a dividend of $3 this year. The dividends you expect to grow at...

Moon Inc. paid a dividend of $3 this year. The dividends you expect to grow at 3% a year forever. The risk free rate is 3% and you require a risk premium of 5%. What is the value of the stock based on the dividend discount model? (10 points)? If the price of the stock in the market is $60 a share, should you buy it and why?

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Answer #1

Given about Moon Inc.'s stock,

Dividend paid D0 = $3

dividend growth rate g = 3%

risk free rate = 3%

required risk premium on stock = 5%

So, required return on stock rs = risk free rate + risk premium = 3 + 5 = 8%

Value of the stock today using constant dividend growth model is

P0 = D0*(1+g)/(rs - g) = 3*1.03/(0.08 - 0.03) = $61.80

So, intrinsic value of stock today is $61.80

actual price of stock today = $60

Since stock is underpriced, i.e. current price of the stock is less than expected price, stock price is expected to increase in near future. So, stock should be purchased.

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