Question

Estimate the intrinsic value for 2019 for Dodger Dogs, Inc. (DD), using the Constant Growth Model given the following information. Your estimation period is the most recent five years ending in 2018. You believe that the dividend growth rate provides a good estimation for future growth and you have an opportunity cost of 15%.

Answer 1

Option (c) is correct

As per Constant growth model or Gordon model, share price is given by:

Share price = D1 / k -g

 

where, D1 is next years' dividend, k is the required rate of return = 15% and g is the growth

First we will calculate the growth rate in dividends by the following formula:

FV = P * (1 + r)10

 

where, FV = Future value = Dividend per share in 2014 = $1.02, P is dividend per share in 2013 = $0.94, r is growth rate and n is 1 years

 

Now, putting these values in the above formula, we get,

             $1.02 = $0.94 * (1 + r)1

$1.02 / $0.94 = (1 + r)

       1.085106 = 1 + r

                      r = 1.085106 - 1

                      r = 0.085106 or 8.51%

 

So, annual growth rate in dividends is 8.51%.

 

Next, we will calculate value of D1 i.e. dividend in 2019. Dividend will grow at the rate of 8.51% annually. So we will calculate the D1 by future value formula as per below:

FV = P * (1 + r)n

 

where, FV = Future value, which is the dividend in 2019, P is dividend in 2018 = $1.4, r is the growth rate = 8.51% and n is 1 years.

 

Now, putting these values in the above formula, we get,

FV = $1.4 * (1 + 8.51%)1

FV = $1.4 * (1 + 0.0851)

FV = $1.4 * 1.0851

FV = $1.51914

 

So, value of D1 is $1.51914

 

Now, we will calculate the share price by putting the values in the Gordon Model formula:

Share price = $1.51914 / 15% - 8.51%

Share price = $1.51914 / 6.49%

Share price = $23.42

 

Nearest answer is option (c), whcih is $23.89.

Nearest answer is option (c), whcih is $23.89.