Question

Tangshan​ China's stock is currently selling for​ $90.00 per share and the​ firm's dividends are expected to grow at 5 percent indefinitely. In​ addition, Tangshan​China's most recent dividend was​ $5.50. If the expected risk free rate of return is 3​ percent, the expected market premium is 6​ percent, and Tangshan has a beta of​ 1.2, Tangshan's stock would be​ ________.

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

B.undervalued because the market price is less than the resulting share value

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

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

*What should a rational investor do? How will this affect market efficiency?

Answer 1

required rate of return or KE

=risk free rate of return+beta*expected market premium

=3%+1.2*6%

=10.20%

value of stock=(D0*(1+g))/(KE-g)

=(5.50*(1+5%))/(10.20%-5%)

=111.06 which is higher than the current price of 90

so stock is trading at lower price than its worth

answer: B.undervalued because the market price is less than the resulting share value

the rational investors should invest at it is trading at low price which will provide margin of safety to investors.

this will result in conflict with market efficiency because in market efficiency the assumption is that every thing is incorporate in the prices while here the case is different

the above is answer..