Question

As an investor you have a required rate of return of 14 percent for investments in risky stocks. You have analyzed three risky firms and must decide which of any) to purchase. Your information Firm Current dividends Expected annual growth rate in dividends Current market price $1.00 $3.00 796 29 $7.50 (-19) $60 $23 547 What is the maximum price? Which (if any) should you buy? If you bought Stock A. What is your implied rate of return? If your required rate of return were 10 percent, what should be the price necessary to induce you to buy Stock AZ TT TT Paragraph Arial 3 (12pt) %D0Q TTPE fx Mashups - 1 4 @ @

Answer 1

The price of the stick can be determined using the following formula

$\large P = \frac{D_0\times (1+g)}{r -g}$

Price of stock A

$\large \implies P_A = \frac{1\times (1+0.07)}{0.14 -0.07}$

$\large \implies P_A = \$ \ 15.29$

The current market price is $ 23 this overpriced do not purchase the stock.

Similarly current price of B

$\large \implies P_B = \frac{3\times (1+0.02)}{0.14 -0.02}= \$ 25.50$

The current price is $ 47 and the intrensic value is $ 25.5. The record, Stock B is also overpriced.

Calculation for stock C

$\large \implies P_C = \frac{7.50\times (1-0.01)}{0.14 -(-0.01)}= \$ 49.50$

Current price of stock C is $ 60 and intrinsic value is $ 49.50. Therefore, C is also overpriced dont purchase any of the given stocks.

B. Implied rate of return of stock A

$\large 23 = \frac{1\times (1+0.07)}{r -0.07}$

$\large \implies r - 0.07= \frac{1.07}{23}$

$\large \implies r = 0.04652 + 0.07$

$\large \implies r = 0.11652$

Implied rate of return = 11.65%

C. $\large P_A = \frac{1\times (1+0.07)}{0.10 -0.07}$

$\large \implies P_A = \frac{1.07}{0.03}\approx \$ \ 35.67$