A stock has an expected dividend growth rate of 3.5%. The firm has just paid a dividend of $1.5 per share. With a required rate of return of 8%, the stock is trading at $36.40. The stock is ________.
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A. B. C. D.A
In the usual notation, the Dividend Discount Model gives Po = D1/(k-g). In this case, g = 3.5%, D1 = Do*(1+g) = 1.5 * 1.035 = $1.5525. The price that will give k =
8% equals P = 1.5525/(8% - 3.5%) = $34.5. Since the stock is trading at a price higher than this, it is overpriced (by $1.90).