Mike Brandreth, an analyst who specializes in the electronics industry, is preparing a research report on Dynamic

Question:

Mike Brandreth, an analyst who specializes in the electronics industry, is preparing a research report on Dynamic Communication. A colleague suggests to Brandreth that he may be able to determine Dynamic’s implied dividend growth rate from Dynamic’s current common stock price, using the Gordon growth model. Brandreth believes that the appropriate required rate of return for Dynamic’s equity is 8%.

a. Assume that the firm’s current stock price of $58.49 equals intrinsic value. What sustained rate of dividend growth as of December 2013 is implied by this value? Use the constant growth dividend discount model (i.e., the Gordon growth model).

b. The management of Dynamic has indicated to Brandreth and other analysts that the company’s current dividend policy will be continued. Is the use of the Gordon growth model to value Dynamic’s common stock appropriate or inappropriate? Justify your response based on the assumptions of the Gordon growth model.

Constant Growth dividend Discount Model

High Flyer Industries has just paid its annual dividend of $3 per share. The dividend is expected to grow at a constant rate of 8% indefinitely. The beta of High Flyer stock is 1.0, the risk-free rate is 6%, and the market risk premium is 8%. What is the intrinsic value of the stock? What would be your estimate of intrinsic value if you believed that the stock was riskier, with a beta of 1.25?

Because a $3 dividend has just been paid and the growth rate of dividends is 8%, the forecast for the year-end dividend is $3 × 1.08 = $3.24. The market capitalization rate (using the CAPM) is 6% + 1.0 × 8% = 14%. Therefore, the value of the stock is

If the stock is perceived to be riskier, its value must be lower. At the higher beta, the market capitalization rate is 6% + 1.25 × 8% = 16%, and the stock is worth only

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their...