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Intrinsic Value of a Stock and the Dividend Discount Model

Part I
A company's common stock dividends are anticipated to grow at a constant 5.5% growth rate per year going forward. The company just paid an annual dividend (that is, D-zero) of $3 per share. What's the intrinsic value of the stock based on the following required rates of return?
6%
8%
10%
12%
If the stock is currently selling for $40 per share, is the stock a good buy? Interpret the results and justify your decision.

A company just paid an annual dividend of $1.50 per share. Dividends are anticipated to grow at a rate of 17% per year for the next five years and then reduce down to a growth rate of 8.5% per year forever. The stock's beta is 1.2; the risk-free rate is 4%, and the expected return on the overall stock market is 11%. What's the intrinsic value of the company's common stock?

Part II
Using Walmart (WMT)
Apply the Dividend Discount Model and justify why you think that the stock is currently undervalued, overvalued, or fully valued. Please be sure to state your assumptions and justify your results. What's the relationship, if any, between stockholders' wealth and financial decisions?

Solution Preview

Please see the attached document for a properly formatted solution.

Part I
A company's common stock dividends are anticipated to grow at a constant 5.5% growth rate per year going forward. The company just paid an annual dividend (that is, D-zero) of $3 per share. What's the intrinsic value of the stock based on the following required rates of return? For this part, we'll use the Gordon Growth Model.

Value of stock = DPS1 / Re - G
Where;
DPS1 = dividend 1 year from now
Re = required rate of return
G = dividend growth rate in perpetuity
6%
Value of stock = ($3.00 x 1.055) / 6% - 5.5%
Value of stock = $3.165 / 0.005
Value of stock = $633
8%
Value of stock = ($3.00 x 1.055) / 8% - 5.5%
Value of stock = $3.165 / 0.025
Value of stock = $126.60
10%
Value of stock = ($3.00 x 1.055) / 10% - 5.5%
Value of stock = $3.165 / 0.045
Value of stock = $70.33
12%
Value of stock = ($3.00 x 1.055) / 12% - 5.5%
Value of stock = $3.165 / 0.065
Value of stock = $48.69

If the stock is currently selling for $40 per share, is the stock a good buy? Interpret the results and justify your decision.

The stock is a good buy because its intrinsic value exceeds the current selling price under all the rates of return computed above. For a required rate of ...

Solution Summary

This solution shows the procedure of computing the intrinsic value of a stock using the Gordon Growth Model. The solution also shows the procedure of computing the intrinsic value of a stock that has different growth rates. Lastly, the solution shows how to compute the intrinsic value of an actual company (Walmart) at a given point in time and assess whether the stock is undervalued, overvalued or fully valued.

$2.19