Question

An investor with a required return of 15 percent for very risky investments in common stock has analyzed three firms and must decide which, if any, to purchase. The information is as follows:

Firm		A		B		C
Current earnings	$	2.50	$	2.90	$	6.80
Current dividend	$	2.20	$	4.40	$	7.80
Expected annual growth rate in		5	%	2	%	-2	%
dividends and earnings
Current market price	$	28	$	39	$	46

Stock A: $  

Stock B: $  

Stock C: $  

  %

Stock A: $  

Stock B: $  

Stock C: $  

1. What is the maximum price that the investor should pay for each stock based on the dividend-growth model? Round your answers to the nearest cent.
2. If the investor does buy stock A, what is the implied percentage return? Round your answer to two decimal places.
3. If the appropriate P/E ratio is 14, what is the maximum price the investor should pay for each stock? Round your answers to the nearest cent.
4. If the appropriate P/E ratio is 5, what is the maximum price the investor should pay for each stock? Round your answers to the nearest cent.

   Stock A: $  

   Stock B: $  

   Stock C: $  

Answer 1

a. p= D r-g = 23.1 Stock A = 2.2% (1.05) 0.15 - 0.05 Stock B2 4.4X (1:02) 0.15-0.02 Stock la 7.8*(1-0.02) 0.15+0.02 34.52 . 44.96

b. Inspica heim * 23-1 — 28 Стара, -11 12 с. Роа fпа и АРЕ Д х 2.5 = 3 Рwa w Rok C. 4 х 2-0 г 40-6 Руми 4 яей с 14 х 4 8 - 9 -2 4. Руха в дол 4: 5х 23 - 12 Pae 4 Ири ва 5х2- 02 14 Рku q Acck C = 5х68 = 34