Question #80 - Reading 20 Discounted Dividend Valuation

Reading: Reading 20 Discounted Dividend Valuation

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Shared Context

- Assuming a beta of 1.12, if UC's growth rate is 10% initially and is expected to decline steadily to a stable rate of 5% over the next three years, what is the price of UC stock? A) $47.82. B) $46.61. C) $47.67.

Question

UC Inc. had earnings of $3.00/share last year and a justified trailing P/E of 15.0. Is the stock currently overvalued, undervalued, or fairly valued if we consider a security trading within a band of ±10 percent of intrinsic value to be within a "fair value range"? At a market price of $40.38, UC Inc. is best described as:

Answer Choices:

A. undervalued

B. fairly valued

Explanation

The justified trailing P/E or P0/E0 is V0/E0, where V0 is the fair value based on the stock's fundamentals. The justified trailing P/E is given as 15, so the fair value V0 based on an E0 of $3.00 can be computed as 15 × 3.00 = $45.00. Thus at a market price of $40.38, UC Inc. is undervalued by slightly more than 10%.

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