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2. A share of Smartphone Corporation’s common stock just paid an annual dividend of $2.42 (i.e.,...

2. A share of Smartphone Corporation’s common stock just paid an annual dividend of $2.42 (i.e., D0 = $2.42), and the company’s dividend is expected to grow for a long, long time at 7% per year. You require an 11% annual rate of return for this kind of investment. A share of Smartphone’s common stock currently trades for $89.25. Do you buy a share? Why, or why not?

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Answer #1

Fair Value of Stock = D1 / [ Ke - g ]

D1 = D0 (1+g)

= $ 2.42 * ( 1+0.07)

= $ 2.42 * 1.07

= $ 2.5894

Fair Value of Stock = D1 / [ Ke - g ]

= 2.5894 / [11% - 7% ]

= 2.5894 / 4%

= $ 64.74

As Fair Price < Actual Price, STokc is Overpriced. Hence not suggested to buy the stock.

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