Question

P10-7 (similar to) Question Help (Common stock valuation) Wayne, Inc.'s outstanding common stock is currently selling in the market for $28. Dividends of $3.33 per share were paid last year, return on equity is 24 percent, and its retention rate is 24 percent. a. What is the value of the stock to you, given a required rate of return of 17 percent? b. Should you purchase this stock? a. Given a required rate of return of 17 percent, the value of the stock to you is $ . (Round to the nearest cent.)

Answer 1

Growth rate, g = ROE * Retention rate

g = 24% * 24% = 5.76%

This question requires application of constant growth dividend discount model according to which: Div Po r-g Po Price of Stock Div Estimated Dividends for Next Period r = Required Rate of Return g= Growth Rate

Div1 = $3.33 * (1 + 5.76%) = $3.5218

$P_0 = \frac{3.5218}{0.17 - 0.0576}$

---> Answer a

b) Given the stock is currently trading in market at $28, which is less than intrinsic value of stock at $31.33, hence buy more of the stock