Question

Your required rate of return is 11% and the stock price of "LBJ Corp." is $55.50. Next year's dividend is forecasted to be $3.50 per share. The growth rate of dividends is a constant 5.0%. "LBJ Corp." is:

Multiple Choice

• Fairly valued

• Undervalued

• Overvalued

Answer 1

Expected Return of LBJ Corp
= (D1 / P0) + g
Where,
D1 = Next Year's Dividend = $3.50
P0 = Current Stock Price = $55.50
g = Constant Growth Rate of Dividend = 5% = 0.05
So,
Expected Return of LBJ Corp
= (D1 / P0) + g
= ($3.50 / $55.50) + 0.05
= 0.0631 + 0.05
= 0.1131
i.e. 11.31%
Expected Return (11.31%) is more than that of the
Required Rate of Return (11%), So stock price
of LBJ Corp is undervalued.
Therefore, LBJ Corp is undervalued.