You receive a great stock tip from your broker. He suggests you should purchase GHI Industries. GHI Industries just paid a $1.72 dividend per share. Its dividend is expected to increase for the next three years at 12% per year and thereafter at 9% per year. Assume your required rate of return is 16%.
a. Calculate the intrinsic value of this stock using the dividend discount model (“DDM”).
b. Assume that the Beta for GHI Industries is 1.15. The risk free rate is 4.50% and the expected market return is 14.50%. Using the CAPM formula, prove that the market capitalization rate or required rate of return is 16%.