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Terminal value calculation using Gordon constant growth model

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I am an analysts valuing the stock of a company. I have projected earnings and dividends three years out (to t=3), and have gathered the following data and estimates:

* Required rate of return = .10
* Average dividend payout rate for mature companies in the market = .45
* Industry average ROE= .13
* E3 = $3.00 (EPS at end of t=3)
* Industry average P/E = 14.3

Based on the above information, calculate terminal value based on comparables (i.e., the value at t=3) and also estimate the terminal value using the Gordon constant growth model.

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Solution Preview

The Gordon constant growth model is a procedure for valuing the price of a stock by using predicted dividends and discounting them back to present value. (The idea is that if the value obtained from the DDM is higher than what the shares are currently trading at, then the stock is undervalued.)
<br>K=0.10
<br>dividend payout rate = D/E =0.45
<br>then growth rate = Retaining rate * ROE = (1- ...

$2.19
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