Question

Your task is to value the stock price of Tornado with the Dividend Discoht Möer (DDI growth. You have the following information Recent dividends per share (DIVo) Risk-free rate (r) Beta of the stock (β) Average stock return on the market Estimated long-term dividends growth rate g 5.32 3.75% 1.7084 1096 3% 1) Calculate the value of the stock of Tormado using the Dividend Discount Model (D stable growth. 2) The stock currently trades at 34.71 in the stock market; would you recommend buying

Answer 1

The value of stock using dividend discount model is expected dividend / (cost of equity - growth rate)

Cost of equity can be found out by using CAPM model as risk free rate + beta(market risk premium) i.e = 3.75% + 1.7084(10% - 3.75%)

= 3.75% + 1.7084(6.25%) = 3.75% + 10.6775%

= 14.4275%

Expected dividend = €5.32(1+0.03) = €5.4796

So the value of stock = €5.4796/(14.4275% - 3%)

= €5.4796/11.4275% = €47.95

So the value of the stock using dividend discount model is 47.95.

The stock is trading at €34.71 which is less than the expected value of €47.95. Here the stock is undervalued and hence one should buy the stock from the market at €34.71