Tangshan China's stock is currently selling for $160.00 per share and the firm's dividends are expected to grow at 5 percent indefinitely. In addition, Tangshan China's most recent dividend was $5.50. If the expected risk free rate of return is 3 percent, the expected market return is 8 percent, and Tangshan has a beta of 1.2, Tangshan's stock would be ________.
A) overvalued because the market price is higher than the resulting share value
B) undervalued because the market price is less than the resulting share value
C) overvalued because the resulting share value is higher than the market value
D) undervalued because the resulting share value is less than the market value

Question

Quizplus · Accepted Answer

To determine if Tangshan China's stock is overvalued or undervalued, we first calculate the required rate of return using the Capital Asset Pricing Model (CAPM): Required Rate of Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate) = 3% + 1.2 * (8% - 3%) = 9%. Next, we use the Gordon Growth Model to find the intrinsic value of the stock: Price = Dividend * (1 + Growth Rate) / (Required Rate of Return - Growth Rate) = $5.50 * (1 + 0.05) / (0.09 - 0.05) = $143.75. Since the market price ($160) is higher than the calculated intrinsic value ($143.75), the stock is overvalued.

Tangshan China's Stock Is Currently Selling for $160