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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Investing in Stocks

A company's share is expected to pay a dividend of Rs 12 next year. Dividends are expected to grow at a constant 6% per annum indefinitely. Investor Rohan requires a return of 14%. Using the constant growth dividend discount model, what is the intrinsic value of the share, and if the market price is Rs 170, what is the appropriate conclusion?

Intrinsic value is Rs 150, found by dividing the next dividend of Rs 12 by the difference between required return 14% and growth 6%. As the market price of Rs 170 is above this, the share appears overvalued for Rohan.

  1. ARs 150; the share is overvaluedCorrect
  2. BRs 150; the share is undervalued
  3. CRs 200; the share is undervalued
  4. DRs 85.7; the share is overvalued

Explanation

Value = D1/(r - g) = 12/(0.14 - 0.06) = 12/0.08 = Rs 150. Market price of Rs 170 exceeds this, so the share is overvalued. Rs 200 comes from using 12/0.06, a wrong denominator. Rs 85.7 uses 12/0.14, ignoring growth.

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