A stock recently paid a dividend of $3 per share. Its growth rate is expected to be 8 percent. Investors require a 10 percent return. The stock is selling in the market for $140. What is this stock worth and is the stock undervalued or overvalued?
A) $162; undervalued
B) $162; overvalued
C) $150; undervalued
D) $150; overvalued

Question

Quizplus · Accepted Answer

The stock's value can be calculated using the Gordon Growth Model (Dividend Discount Model for a perpetuity with growth), which is P = D / (r - g), where P is the price, D is the dividend, r is the required rate of return, and g is the growth rate. Plugging in the values: P = $3 / (0.10 - 0.08) = $3 / 0.02 = $150. Since the stock is selling for $140 but is worth $150, it is undervalued.

A Stock Recently Paid a Dividend of $3 Per Share