Question

Mature Conglomerate Corporation (MCC) just paid a dividend of $1.35 per share, and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company's beta is 1.15, the required return on the market is 12.50%, and the risk-free rate is 4.00%. What is the intrinsic value for MCC’s stock? Enter your answer rounded to two decimal places. Do not enter $ or comma in the answer box. For example, if your answer is $12,300.456 then enter as 12300.46 in the answer box.

Answer 1

Solution:

a.Calculation of Cost of equity:

The Cost of equity of a firm is calculated using the following formula:

Cost of equity = R_F + [ β * ( R_M - R_F ) ]

Where

R_F = Risk free rate of return   ; β = Beta of the firm ;   R_M = Required return on the market

As per the information given in the question we have

R_F = 4 %   ; R_M = 12.50 %   ;   β = 1.15

Applying the above values in the formula we have

= 4 % + [ 1.15 * ( 12.50 % - 4 % ) ]

= 4 % + [ 1.15 * 8.50 % ]

= 4 % + 9.7750 %

= 13.7750 %

Thus the cost of equity for the firm is = 13.775 %

b.Calculation of Intrinsic value of Stock :

As per the Gordon growth Model price of a share of a firm is calculated using the following formula:

P = D₀ * [ ( 1 + g ) ] / ( k_e – g )

Where

P = Price of the share;      D₀ =Recent dividend paid ; g = growth rate ;

k_e = Cost of equity

As per the information given in the question we have ;

D₀ = $ 1.35 ;       g = 6.00 % = 0.06 ;    k_e = 13.775 % = 0.13775

Applying the above values in the formula we have

= [ 1.35 * ( 1 + 0.06 ) ] / ( 0.13775 – 0.06)

= (1.35 * 1.06 ) / 0.07775

= 1.4310 / 0.07775

= $ 18.4051 per share

= $ 18.41 per share ( when rounded off to two decimal places )

Thus the Intrinsic value for MCC’s stock = $ 18.41 per share.