DAA's stock is selling for $15 per share.The firm's income, assets, and stock price have been growing at an annual 15 percent rate and are expected to continue to grow at this rate for 3 more years.No dividends have been declared as yet, but the firm intends to declare a dividend of = $2.00 at the end of the last year of its supernormal growth.After that, dividends are expected to grow at the firm's normal growth rate of 6 percent.The firm's required rate of return is 18 percent.The stock is

Question

DAA's stock is selling for $15 per share.The firm's income, assets, and stock price have been growing at an annual 15 percent rate and are expected to continue to grow at this rate for 3 more years.No dividends have been declared as yet, but the firm intends to declare a dividend of  = $2.00 at the end of the last year of its supernormal growth.After that, dividends are expected to grow at the firm's normal growth rate of 6 percent.The firm's required rate of return is 18 percent.The stock is

Quizplus · Accepted Answer

We can use the dividend discount model (DDM) to value the stock at the end of year 3, when supernormal growth ends and the normal growth rate of 6% begins:
D3 = D2 × (1 + g) = $2.00 × (1 + 6%) = $2.12
P3 = D3 ÷ (r - g) = $2.12 ÷ (18% - 6%) = $15.13
To find the current stock price, we need to discount P3 back to present:
P0 = P3 ÷ (1 + r)³ = $15.13 ÷ (1 + 18%)³ = $9.81
The current stock price of $15 is higher than the calculated value of $9.81, indicating that the stock is overvalued by $3.19. Therefore, the correct answer is B, overvalued by $3.03.

DAA's Stock Is Selling for $15 Per Share