Here, we are given all the inputs we need. Use the following steps to calculate the value of the stock:
First, expand the infinite period DDM:
DDM formula: P0 = D1 / (ke – g)
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D1 |
= (Earnings × Payout ratio) / average number of shares outstanding |
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= ($150,000 × 0.60) / 75,000 = $1.20 |
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ke |
= nominal risk free rate + [beta × (expected market return – nominal risk free rate)] |
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Note: Nominal risk-free rate |
= (1 + real risk free rate) × (1 + expected inflation) – 1 |
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= (1.04)×(1.03) – 1 = 0.0712, or 7.12%. |
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ke |
= 7.12% + [2.1 × (13.0% − 7.12%)] = 0.19468 |
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g |
= (retention rate × ROE) |
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Retention |
= (1 – Payout) = 1 – 0.60 = 0.40. |
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ROE |
= (net income / sales)(sales / total assets)(total assets / equity) |
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= (150,000 / 1,000,000)(1,000,000 / 800,000)(800,000 / 400,000) |
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= 0.375 |
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g |
= 0.375 × 0.40 = 0.15 |
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Then, calculate: P0 = D1 / (ke – g) = $1.20 / (0.19468 − 0.15) = 26.86.
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