Question

Pacor Industries recently paid its annual dividend of $2. Dividends have consistently grown at a rate of 2.2%. Analysts estimate that the stock has a beta of 1.12. The current risk-free rate is 2.4% and the market return is 10.7%. Assuming that CAPM holds, what is the intrinsic value of this stock? Group of answer choices $20.67 $21.52 $21.24 $22.19 $20.64

Answer 1

The intrinsic value of the stock is $21.52

Step-by-step explanation:

To calculate the intrinsic value of the stock, we will use the constant growth model of the dividend discount model (DDM). The DDM values the stock based on the present value of the expected future dividends from the stock. The formula for price today under the constant growth model of DDM is,

P0 = D0 * (1+g) / r - g

Where,

• D0 * (1+g) is D1 or the next expected dividend
• r is the required rate of return
• g is the growth rate in dividends

First of all, we need to calculate the r or required rate of return using the CAPM equation,

r = rRF + Beta * (rM - rRF)

Where,

• rRF is the risk free rate
• rM is the return on market

r = 0.024 + 1.12 * (0.107 - 0.024)

r = 0.11696 or 11.696%

P0 = 2 * (1+0.022) / (0.11696 - 0.022)

P0 = $21.52