Question

Todd Mountain Development Corporation is expected to pay a dividend of $3 in the upcoming year. Dividends are expected to grow at the rate of 12% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 16%. The stock of Todd Mountain Development Corporation has a beta of 0.90. Using the constant-growth DDM, the intrinsic value of the stock is _________.

Answer 1

Answer: $100

Explanation:

We can use 2 formulas to calculate the intrinsic value of the stock because of the figures we are given being the Capital Asset Pricing Model and the Constant Growth DDM model.

Figures given are,

D1 = $3

g = 12%

Rf = 6%

Rm = 16%

Be = 0.90

We will use CAPM to calculate the Expected Return on the stock, the formula is

Re = Rf + (Rm-Rf)*Be

Rf is the risk free rate

Rm is the market rate

Be is the beta

Re = 0.06 + (0.16-0.06)*0.9

Re = 15%

Now using the constant-growth DDM, the intrinsic value of the stock is,

Po = D1/(Re-g)

Where

D1 is the next dividend

Re is the expected return

g is the growth rate

Plugging in the figures we have,

Po = 3/(0.15-0.12)

P0 = $100

Intrinsic value is $100