Alice Lee is a buy-side analyst for a large pension fund. She frequently uses dividend discount models (DDM), such as the Gordon growth model, to value consumer non-cyclical stocks that she covers. One of the stocks she covers is Procter & Moris Co(PM). The current dividend for PM is $1.46, and the dividend eight years ago was $0.8497. The current stock price is $118 per share. The dividend payout ratio is 60% and is expected to be stable for the foreseeable future. Alice uses a beta of 0.9 (computed versus the S&P 500 Index)for PM. The risk-free rate of return is 3.2% and the equity risk premium is 5.5%.

Using the Gordon growth model, what is the fair value of PM assuming the future dividend growth rate will be exactly the same as the historical rate and what recommendation should Alice issue?

Value Recommendation

a.

$129.96 Issue a buy

b.

$226.08 Issue a buy

c.

$135.65 Issue a buy

d.

$ 19.14 Issue a sell