Question

Todd Mountain Development Corporation is expected to pay a dividend of $2 in the upcoming year. Dividends are expected to grow at the rate of 7% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 18%. The stock of Todd Mountain Development Corporation has a beta of 0.75. Using the constant-growth DDM, the intrinsic value of the stock is _________.

Answer 1

Answer:

The intrinsic value of the stock is $25

Explanation:

Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D1 / (r - g)

Where,

• D1 is the dividend expected for the next year

• g is the growth rate

• r is the required rate of return  

We first need to calculate r using the CAPM. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.

The formula for required rate of return under CAPM is,

r = rRF + Beta * (rM - rRF)

Where,

• rRF is the risk free rate

• rM is the market rate of return

r = 0.06 + 0.75 * (0.18 - 0.06)

r = 0.15 or 15%

Now we can calculate the price of the stock today.

P0 = 2  /  (0.15 - 0.07)

P0 = $25