You are considering the purchase of a stock with a current market price of $50.25 per share.It is expected to pay a dividend of $5.25 next year.Historically the stock has grown at 5%,and based on its risk,you desire to earn a 15% return.Which of the following is true?

Question

Quizplus · Accepted Answer

To determine the estimated price of the stock, we can use the dividend discount model (DDM). 
Estimated price = (Dividend next year / (Required rate of return - Growth rate))
Substituting the given values: 
Estimated price = (5.25 / (0.15 - 0.05)) =  $ 52.50
Since the estimated price is higher than the current market price ($50.25), the stock is undervalued and should be bought. Therefore, the correct answer is A.

You Are Considering the Purchase of a Stock with a Current