Question

Todd Mountain Development Corporation is expected to pay a dividend of $2.50 in the upcoming year....

Todd Mountain Development Corporation is expected to pay a dividend of $2.50 in the upcoming year. Dividends are expected to grow at the rate of 7% per year. The risk-free rate of return is 3% and the expected return on the market portfolio is 12%. The stock of Todd Mountain Development Corporation has a beta of 1.5. Using the constant growth DDM, the intrinsic value of the stock is _________.

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Answer #1

Step-1, Calculation of the Required Rate of Return (Ke)

As per Capital Asset Pricing Model [CAPM], the Required Rate of Return is computed by using the following equation

Required Rate of Return = Risk-free Rate + Beta[Market Rate of Return - Risk-free Rate]

= 3.00% + 0.5[12.00% - 3.00%]

= 3.00% + [1.5 x 9.00%]

= 3.00% + 13.50%

= 16.50%

Step-2, Intrinsic value of the stock using the Constant Growth DDM

Intrinsic Value of the Stock = Dividend in Year 1 / (Required Rate of Return – Growth Rate)

= D1 / (Ke – g)

= $2.50 / (0.1650 – 0.07)

= $2.50 / 0.0950

= $26.32 per share

“Therefore, the Intrinsic value of the stock will be $26.32”

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