Two Stage Dividend Discount Model

The Dividend per share for 2013 and 2016 are given on Value Line. The dividend growth for the years in between is calculated as follows:

|Dividend ‘13 |.14 |
|Dividend ‘14 |.15 |
|Dividend ‘15 |.17 |
|Dividend ‘16 |.18 |

.18 - .14 = .04; .04/3 = .0133

In order to calculate Value using the 2 stage Dividend Discount Model we must calculate the market capitalization rate (k), as well as forecast the price of the stock for 2016 (P2016).

The market capitalization rate (k) can be calculated using the CAPM formula.

K = rf + β(market risk premium)

We are given a risk free rate of 1%, a beta of 1.45 and the RWJ book gives a market risk premium of 8.2%. By plugging the numbers we can solve for k.

K = 1% + 1.45(8.2%) = 12.89%

Next we need to forecast the price for the stock for the year 2016 (P2016). The first step in forecasting the price is to calculate the growth (g) rate of the stock.

g = ROE(1-dividend payout ratio)

The Value Line tear sheet gives us both the ROE (8.0%) and the dividend payout ratio (13%). By plugging in the numbers we can solve for g.

g = 8%(1-13%) = 6.96%

Now that we found the growth rate we can use it to forecast the future price of the stock in 2016.

P2016 = D2016(1+g)/(k-g)

We have already calculated the dividend for 2016, the market capitalization rate and the growth rate. By plugging in these numbers we can solve for P2016.

P2016 = .18(1.0696)/(.1289-.0696) = 3.24667

Now that we have calculated the dividends for the 4 years, the market capitalization rate and the forecasted stock price for 2016, we are ready to solve for the current value of the stock using the dividend discount model.

V2012=[D2013/(1+k)]+[D2014/(1+k)2]+[D2015/(1+k)3]+[(D2016+P2016)/(1+k)]

V2012 =