Question 6 Steve Colonnello has started a new job and has strong interest in put

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Question 6 Steve Colonnello has started a new job and has strong interest in putting his extra cash to work and will be looking to invest in the U.S. Stock Market. As a valued investor, one of his primary concern is how to value the stock prices. Using PIE multiples to conduct Valuation by Comparables is one of criteria. He is also interested in calculating the stock?s intrinsic value using Dividend Growth Model. Given the information he has accumulated from his research work: (a) Johnson & Johnson: Beta = 1.14 Growth rate = 3.2% Current dividend = $1.05 Required rate of return = 6.4% (b) Dow Chemical: Beta = 0.97 Growth rate = 2.6% Current dividend = $1.05 Required rate of return = 6.4% (c) Chevron: Beta = 0.84 Growth rate = 4.5% Current dividend = $1.86 Required rate of return = 8.9% What are the fair values of each of these stock? If Chevron stock is selling for S20,0, what does that imply? Buy, or not to buy? YOU MUST SHOW YOUR CALCULATIONS:

Explanation / Answer

(a) Calculation of Johnson and Johnson's fair value:

Fair price = current dividend/(required rate of return - growth rate)

= 1.05/(0.064-0.032) = $32.81

(b) Calculation of Dow Chemical's fair value:

Fair price = current dividend/(required rate of return - growth rate)

= 1.05/(0.064-0.026) = $27.63

(c) Calculation of Chevron's fair value:

Fair price = current dividend/(required rate of return - growth rate)

= 1.86/(0.089-0.045) = $42.27

If, the Chevron stock is selling for $20, it means that its current price ($20) is less than its intrinsic value ($42.27). The stock should be bought as there is a potential for upside, as the intrinsic value is higher than the current price at whick the stock is being traded in the secondary market.

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