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

To calculate the value of the stock, we need to use the dividend discount model.

The dividends during the supernormal growth period (3 years) can be calculated using the formula:

D1 = D0 × (1 + g)

Where D1 is the dividend at the end of year 1, D0 is the current dividend (which is zero in this case), and g is the growth rate (which is 15%).

Therefore, D1 = 0 × (1 + 15%) = 0

Similarly, D2 = 0

And, D3 = 2.00

To calculate the present value of the dividends during the supernormal growth period, we use the formula:

PV = D1/(1+r) + D2/(1+r)² + D3/(1+r)³

Where r is the required rate of return (which is 18%).

Therefore, PV = 2.00/(1+18%)³ = 1.08

To calculate the present value of the dividends during the normal growth period, we use the formula:

PV = D4/(r-g)

Where D4 is the dividend at the end of year 4, and g is the normal growth rate (which is 6%).

Therefore, PV = 2.00 × (1+6%)/(18%-6%) = 26.00

To calculate the present value of the stock, we add the present values of the dividends during the supernormal and normal growth periods:

PV = 1.08 + 26.00 = 27.08

Since the current stock price is $15, the stock is overvalued by $12.08.

The correct option is B, overvalued by $3.03 (since $12.08 - $15 = -$3.03).

DAA's Stock Is Selling for $15 Per Share