Question

Your task is to value the stock price of Tornado with the Dividend Discount Model (DDM) growth. You have the following information: Recent dividends per share (DIVo) Risk-free rate (rr) Beta of the stock (β) Average stock return on the market n Estimated long-term dividends growth rate g 5.32 3.75% 1.7084 10% 3% 1) Calculate the value of the stock of Tormado using the Dividend Discount Model (DDM stable growth. 2) The stock currently trades at 34.71 in the stock market; would you recommend buying it?

Answer 1

1) First find cost of equity using capm model
=Riskfree+(beta*(market return-riskfree))
=3.75%+(1.7084*(1-%-3.75%))
=14.43%
According to DDM model
price of stock= Div0*(1+g)/(k-g)
Div0=5.32
g=3%
k=14.43%
value=5.32*(1+3%)/(14.43%-3%)
=47.95

2)The price as per DDM model is higher than current market price means the stock is undervalued and i would recommend it to buy