Question

Adidas stock has a beta of 1.3. The risk-free rate is 2.7% and the expected return on the market portfolio is 10%. The company has just paid an annual dividend of $0.25. Dividends are expected to grow by 2% per year.

Part 1

What is the appropriate discount rate?

Part 2

What is the intrinsic value (fair price) of the stock?

Answer 1

Part a:

Beta = 1.3

Red = Risk free rate = 2.7%

Rm = market return = 10%

Appropriate discount rate can be calculated using the CAPM approach

Appropriate discount rate = Rf + beta*(Rm-Rf)

= 2.7% + 1.3*(10% - 2.7%)

= 2.7% + 9.49%

= 12.19%

Therefore, appropriate discount rate is 12.19%

Part b:

D0 = current dividend = $0.25

g = growth rate = 2%

r = discount rate = 12.19%

D1 = Expected dividend = D0 * (1+g) = $0.25*(1+2%) = $0.255

Intrinsic value of the share = D1 / (r - g)

= $0.255 / (12.19% - 2%)

= $0 255 / 0.1019

= $2.50245339

Therefore, intrinsic value of share is $2.50