You got a high-paying job as a security analyst for a hedge fund. Your employer

Question

You got a high-paying job as a security analyst for a hedge fund. Your employer wants your opinion about XWZ common stock which currently sells for $92.50 per share and which recently paid a dividend of $3.95 per share. In ten years dividends per share have grown steadily from $2.4 to $3.95. You believe that dividends will continue to grow at the same rate for the indefinite future. He only tells you that he requires a rate of return of 12.5%. You opine that,

the stock is overpriced, and that he should not pay more than $69.76

the stock is overpriced, and that he should not pay more than $89.76

the stock is underpriced, and that it should be selling for $99.76

the stock is underpriced, and that it should be selling for $95.76

the stock is overpriced, and that he should not pay more than $56.18.

Explanation / Answer

Fv is 3.95, pv is 2.4, N is 10, so yearly growth rate is 5.12%.

As per divedend discount model price = D1/(r-g) = 3.95×(1.0512)/(12.5% - 5.12%) = 56.2$

So the stick is overpriced and he shoud not pay more than 56.18$

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