Question

Jet, Inc. just paid a dividend $2.00 per share. The firm’s stock is selling today in the market for $70 per share. The dividend is expected to grow at the rate of 7% per year for the foreseeable future. If you require a return of 10% on this stock should you purchase it?

No, because the stock is overpriced $3.33.

Yes, because the stock is underpriced $3.33.

No, because the stock is overpriced $1.33.

Yes, because the stock is underpriced $1.33.

Yes, because the stock is overpriced $3.33.

Answer 1

The value of the stock is computed as shown below:

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

= ($ 2 x 1.07) / (0.10 - 0.07)

= $ 71.33

Since the current market price of $ 70 is less than the fair value of $ 71.33, hence the stock is undervalued by $ 1.33

So, the correct answer is option of Yes, because the stock is underpriced $1.33.

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