QUESTION 12 Suppose you observe the following information about Lateway Inc., a

Question

QUESTION 12

Suppose you observe the following information about Lateway Inc., a provider of firewall software.

                  Price:  $40                              Long-run Growth: 6%

                  Beta:   1.75                             Market Risk Premium: 6%

                  Rf: 4.5%                                  D1: $4.00

Is this security fairly priced? If not, would you buy it or sell it, and why?

Suppose you buy 1,000 shares of Lateway at $40 per share. One year later Lateway pays a dividend of $3.75 and you sell your shares for $47. What is your rate of return on your investment?

Explanation / Answer

k = 4.5 + 1.75(6) = 15%

Price of share = 4/(.15 - .06) = 44.44

the share is underprice and should be brought

return = (47 + 3.75)/40 - 1 = 26.9%

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