Question

B) The common stock of AMT paid RM1.32 in dividends last year. Dividends are expected to grow at an 8 percent annual rate for an indefinite number of years.

i. If AMT’s current market price is RM23.50, what is the stock’s expected rate of return?

ii. If your required rate of return is 10.5 percent, what is the value of the stock for you?

iii. Should you make the investment, and why?

Answer 1

Dividend paid in last year = RM 1.32

Growth rate = 8%

(i)

Current market price = RM 23.50

Expected rate of return = (D₁/P₀)+g

Whereas D₁ = Expected dividend i.e. 1.32*1.08 = RM1.4256

P₀ = Current market price;

g = Growth rate

Expected rate of return = (1.4256/23.50)+0.08

= 14.07%

(ii)

If required rate of return is 10.5%, then value of the stock:

Value of the stock = D1/(Re-g)

= 1.4256/(0.105-0.08)

= RM 57.024

(iii) Since the Required rate of return < Expected return, This is due to the stock being undervalued i.e. stock gives more return than what it should give and Current market price is lower than its intrinsic value, therefore we should make investment.