From the scenario, value a share of TFC’s stock using a growth model method and
ID: 2778820 • Letter: F
Question
From the scenario, value a share of TFC’s stock using a growth model method and compare that value to the current trading price of a share of TFC. Determine whether the stock is undervalued or overvalued. Provide a rationale for your response.
In the TFC scenario, growth rate of 10% and the required rate of return $15, the dividends at a flat rate of $10. The Constant growth model is 220. The stated market rate is 220.26. From these data just explain little TFC and the adavanges or risks involved. Can new investors use this model.
Explanation / Answer
Solution:
Gordon growth model helps to analyse whether the stock is undervalued or overvalued by evaluating intrinsic value of the stock. Intrinsic value of stock is true value of stock which excludes all the market impact and perceptions. It takes into consideration the dividend paying capacity of firm and the return which shareholder's expect on their investment. So if the intrinsic value of a stock is more than the current market price of a stock , then the stock will be "undervalued". Because the stock shall have more worth considering its dividend paying ability and return on equity but its trading below that worth. On the contrary , If the intrinsic value of a stock is below market price then the stock will be "overvalued", because the stock doesn't have dividend paying ability & required return on equity as it's worth today.
In The given case , The Intrinsic value of stock is $ 220, whereas the Market price of a stock is $ 220.26.
Therefore , The stock is "overvalued" because after discounting its dividend and expected return on equity shareholder it shall trade below $ 220, which is not the case.
The risk involved in investmnt of TFC stock is it may fall drastically , if company doesn't pay as per its expectation to shareholder.
Yes certainly the new investor can use this model to keep their buying decision on hold by comparing its intrinsic value with market price.
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