Question #50
Reading: Reading 20 Discounted Dividend Valuation
PDF File: Reading 20 Discounted Dividend Valuation.pdf
Page: 20
Status: Incorrect
Correct Answer: A
Your Answer: B
Question
In its most recent quarterly earnings report, Smith Brothers Garden Supplies said it planned to increase its dividend at an annual rate of 5% for the foreseeable future. Analyst Anton Spears is using a required return of 9.5% for Smith Brothers stock. Smith Brothers stock trades for $52.17 per share and earned $3.01 per share over the last 12 months. The company paid a dividend of $2.15 per share during the last 12-month period, and its dividend-growth rate for the last five years was 9.2%. Using the Gordon Growth model, the share price for Smith Brothers stock is most likely:
Answer Choices:
A. overvalued
B. undervalued
C. correctly valued
Explanation
The Gordon Growth model is as follows:
Value = [dividend × (1 + dividend growth rate)] / [required return − growth rate]
Value = [2.15 × 1.05] / [0.095 − 0.05]
= 2.2575 / [0.095 − 0.05]
= 50.17