CA Final · Advanced Financial Management · Security Analysis
Kaveri Foods Ltd has an expected dividend next year of Rs 6 per share, which will grow at 5% perpetually. The required return is 15%. The stock currently trades at Rs 70. What is its intrinsic value under the constant growth model and the investment decision?
Intrinsic value is Rs 60, found as D1 divided by (required return minus growth), i.e. 6 / 0.10. Since the market price of Rs 70 is higher than this value, the share is overvalued and should be sold.
- AIntrinsic value Rs 60; stock overvalued, sellCorrect
- BIntrinsic value Rs 60; stock undervalued, buy
- CIntrinsic value Rs 120; stock undervalued, buy
- DIntrinsic value Rs 40; stock overvalued, sell
Explanation
V0 = D1/(ke - g) = 6/(0.15 - 0.05) = Rs 60. Market price Rs 70 exceeds Rs 60, so the stock is overvalued and should be sold. Rs 120 would arise from wrongly using ke - g = 5%.
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