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# Intrinsic Value of Common Stock - Dividend Growth Method

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Use the dividend growth model to calculate the intrinsic value of MNQ Company's common stock in 2008.

Determine whether the stock is undervalued, overvalued, or fully valued. Justify the assumptions that you make.

#### Solution Preview

The dividend growth model is designed to use the past performance of a company's stock to determine its future growth. Suppose a stockholder is interested in a 10% annual return of stock. She can determine whether or not there is consistent growth in a company by the use of a formula, and applying it to the prospective company's financial statements.

The Gordon Constant Growth Model is a useful general guide, although in a real company growth is neither constant nor consistent.

The current dividend is the latest dividend payout per share.
Growth of the dividend (per year - the five year dividend growth can give you a good idea)
Required rate of return: What you "need" the investment to return in order for you to think it worth it to purchase the stock. (We will say 10%)
Plugging in the numbers ...

#### Solution Summary

This describes the dividend growth model, a variation of present value, to determine the ability of a company to provide a minimum level of annual growth in common stock dividends.

\$2.19

## Stock Valuation Methods

Questions:

1.- How should Jonathan describe the rationale of the dividend discount model (DDM)
and demonstrate its use in calculating the justifiable price of common stock?

2.- Being a researcher, Dwayne asked Jonathan a key question, "How did you
estimate the growth rates used in applying the model?" Using the data giving in Tables 1
and 2 explain how Jonathan should respond.

3.- what is the rationale of the required rate of return that Jonathan used and how did he estimate it?

4.- "What other variations of the DDM can one use and Why?" asked Dwayne. What
should Jonathan respond be?

5.- " Why are you using dividends and not earning per share, Jonathan?" asked
Dwayne. What do you think Jonathan would have said?

6.- Dwayne wondered whether pharmcopia's preferred stock would be a better
investment than its common stock, given that it was paying a dividend of \$1.50
and trading a price of \$15. He asked Jonathan to explain to him the various features
of preferred stock, how it differed from common stock and corporate bonds, and
the method that could be used for estimating its value.