Question

Mosser Corporation common stock paid $2.27 in dividends last year and is expected to grow indefinitely at an annual 6 percent rate.

(a) If Mosser Corporation current market price is $30.08 per share, what is the stock's expected rate of return?

(b) If your required rate of return is 16% percent, what is the value of the stock for you?

(c) Should you make the investment? Why?

Answer 1

Given about Mosser Corporation,

Company paid dividend last year D0 = $2.27

dividend growth rate g = 6%

a). Current stock price P0 = $30.08

Based on stock price and constant dividend growth model, expected return on the stock is

Ke = D0*(1+g)/P0 + g = 2.27*1.06/30.08 + 0.06 = 14%

stock's expected rate of return is 14%

b). With a required return rs = 16%

Stock price today using constant dividend growth model is

P0 = D0*(1+g)/(rs - g) = 2.27*1.06/(0.16-0.06) = $24.06 per share

So,intrinsic value of stock today is $24.06 per share.

c). If stock is selling for $30.08 per share, then it is overpriced in the current market. Since intrinsic value is less than original stock price, stock price is expected to go down. So, this investment should not be made.