A Value and Price You plan on holding a stock for two years

A.

Value and Price You plan on holding a stock for two years. The annual dividend per share is $0.77 and you believe you will be able to sell the stock in two years for $26.00. You believe this stock should pay a 8% rate of return per year. If the stock is currently priced at $22.00 the stock is __________________.

overvalued by less than 5%

overvalued by more than 5%

undervalued by less than 5%

undervalued by more than 5%

B.

Value and Returns A stock has an expected dividend yield of 4.8% a price today of $41 and an expected sale price in one year of $45. The stock has a beta of 0.5 and the expected return on the market is 14% while the risk free rate is 6%. This stock is _____________ by ________ basis points.

overvalued; 456

undervalued; 152

overvalued; 152

undervalued; 456

Solution

1-

required rate of return

8%

rate of return

dividend yield + capital gain yield

dividend yield

total dividend earned/ purchase price

(.77*2)/22

7%

capital gain yield

(future price-current price)/current price

(26-22)/22

18%

total rate of return

25%

required rate of return

8%

overvalued by more than 5%

17%

2-

required rate of return

risk free rate+(market return-risk free return)*beta

6+(14-6)*.5

10%

rate of return

dividend+(future price-present price) / present price

1.968+(45-41)/ 41

14.56%

Difference in rate of return

14.56-10

0.0456

Overvalued by 456 point