You are considering investing in B & B, Inc.'s stock and your broker has told you that you can purchase it for $72. You require a return 12% for this type of investment. The last dividend (D₀)that B & B paid was $4 and a 6% constant growth rate is anticipated. Should you purchase B & B, Inc.?

Question

Quizplus · Accepted Answer

The stock's value can be calculated using the Gordon Growth Model: P = D1 / (k - g), where P is the price, D1 is the dividend next year, k is the required rate of return, and g is the growth rate. D1 = D0 * (1+g) = $4 * (1+0.06) = $4.24. Thus, P = $4.24 / (0.12 - 0.06) = $70.67. Since the stock can be purchased for $72, it is overpriced by $1.33.

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