Question

Sally's stock is currently selling for $160.00 per share and the firm's dividends are expected to...

Sally's stock is currently selling for $160.00 per share and the firm's dividends are expected to grow at 5 percent indefinitely. In addition, Sally’s most recent dividend was $5.50. If the expected risk free rate of return is 3 percent, the expected market premium is 4 percent, and Sally has a beta of 1.2, Sally 's stock would be ________.

A.

overvalued because the market price is higher than the resulting share value
B.

overvalued because the resulting share value is higher than the market value
C.

undervalued because the resulting share value is less than the market value
D.

undervalued because the market price is less than the resulting share value
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Homework Answers

Answer #1

Risk-free Rate = 3.00%
Market Premium = 4.00%
Beta = 1.20

Required Return = Risk-free Rate + Beta * Market Premium
Required Return = 3.00% + 1.20 * 4.00%
Required Return = 7.80%

Recent Dividend, D0 = $5.50
Growth Rate, = 5.00%
Required Return, r = 7.80%

D1 = D0 * (1 + g)
D1 = $5.50 * 1.05
D1 = $5.775

Intrinsic Value = D1 / (r - g)
Intrinsic Value = $5.775 / (0.078 - 0.05)
Intrinsic Value = $206.25

Sally’s stock would be undervalued because the market price is less than the resulting share value.

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