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Stock Z’s beta coefficient is b Z = 0.9. The risk-free rate is 6 percent, and...

Stock Z’s beta coefficient is b Z = 0.9. The risk-free rate is 6 percent, and the expected return on an average stock is 11 percent. The current price of Stock Z, P 0, is $80; the next expected dividend, D 1, is $2.80; and the stock’s expected constant growth rate is 9.5 percent. Which of the following is correct?

a.

Stock Z is overvalued. Its price will rise to restore equilibrium.
b.

Stock Z is undervalued. Its price will fall to restore equilibrium.
c.

Stock Z is undervalued. Its price will rise to restore equilibrium.
d.

Stock Z is overvalued. Its price will fall to restore equilibrium.
e.

Stock Z is fairly priced and in equilibrium.
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Answer #1

Equilibrium Price = D1 / [ Ke - g ]

= 2.80 / [ 11% - 9.5% ]

= 2.80 / 1.5%

= 186.67

Current Price = $ 80

Stock ois Under Priced as Current price < Equilibrium Price.

Thus it will Inc from $ 80 to $ 186.67 to reach Equilibrium price.

Hence STock is Under Valued and it will Increase to reach Equlibrium

Option C is correct.

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