Question

A company just paid a dividend of \$2.16. The dividend is expected to grow at a...

1. A company just paid a dividend of \$2.16. The dividend is expected to grow at a rate of 3.5%. If it is required rate of return on the stock is 8.0% and the stock is currently priced at \$49.20, should they buy or sell?

 You should buy it: it is overvalued by \$0.48. You should buy it: it is undervalued by \$0.48. You should sell it: it is undervalued by \$1.20. You should sell it: it is overvalued by \$1.20. You should sell it: it is overvalued by \$0.48.
2. 12 years ago, your aunt and uncle decided to invest their entire tax refund from Uncle Till of \$2,896 in an account that earns a 6.5 percent annual interest. Assuming annual compounding, how much do they have in the account today?

 \$5,827.32 \$6,023.44 \$6,165.86 \$6,218.03 None of the above

The value of the stock is computed as shown below:

= Dividend just paid x (1 + growth rate) / (required return - growth rate)

= (\$ 2.16 x 1.035) / (0.08 - 0.035)

= \$ 2.2356 / 0.045

= \$ 49.68

Since the current price of the stock is less than the fair value of the stock. Hence the stock is undervalued by \$ 0.48 as shown below:

= \$ 49.68 - \$ 49.20

= \$ 0.48

So, the correct answer is option of You should buy it: it is undervalued by \$0.48.

The amount is computed as shown below:

Future value = Present value x (1 + r)n

= \$ 2,896 x 1.06512

= \$ 6,165.86 Approximately

Feel free to ask in case of any query relating to this question

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