Currently Omega Corporation’s shares are selling at $60 per share and company is

Question

Currently Omega Corporation’s shares are selling at $60 per share and company is paying $5 per share dividend. Dividends are expected to grow at an annual rate of 3% for foreseeable future. Required rate of return for investors is 12%. At the same time, Heller Corporation’s shares are selling at $58 per share and company is paying $4 per share dividend. Dividends are expected to grow at an annual rate of 5% for foreseeable future. Required rate of return for investors is 12%

a. Calculate the current value of each stock on the basis of Dividend Discount Model.

b. On the basis of above calculation, determine either each stock is overvalued or undervalued.

Explanation / Answer

a.    Omega Corporation Current dividend D0 5 Growth rate 3% So, D1= 5(1.03)= 5.15 Stock price= D1/(r-g) ie. 5.15/(0.12-0.03) 57.22222 ie.57.22 Heller Corporation Current dividend D0 4 Growth rate 5% So, D1= 4(1.05)= 4.2 Stock price= D1/(r-g) ie. 4.2/(0.12-0.05) 60 ie.60 b. Current selling price Stock price as per DDM Omega Corporation 60 57.22 Over-valued Heller Corporation 58 60 Under-valued

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