Nicholas Inc. just paid a $2.00 dividend on its common stock and expects to continue growing dividends at an average rate of 5% each year, from now to infinity. If the required rate of return for this stock is 9% and it is currently selling for $54.50 per share, the stock A. selling for exactly its intrinsic value. B. there is not information to determine if the stock is overpriced or underpriced. C. underpriced. D. overpriced.
Question
Nicholas Inc. just paid a 54.50 per share, the stock A. selling for exactly its intrinsic value. B. there is not information to determine if the stock is overpriced or underpriced. C. underpriced. D. overpriced.
Solution
Based on the given information, we can determine if the stock is overpriced or underpriced by calculating its intrinsic value. To do this, we can use the dividend discount model (DDM) formula:
Intrinsic Value = Dividend / (Required Rate of Return - Dividend Growth Rate)
Given that the dividend is $2.00, the required rate of return is 9%, and the dividend growth rate is 5%, we can substitute these values into the formula:
Intrinsic Value = 2.00 / 0.04 Intrinsic Value = $50.00
Since the current selling price of the stock is $54.50 per share, we can compare it to the calculated intrinsic value.
If the stock is selling for exactly its intrinsic value, the answer would be A. selling for exactly its intrinsic value.
If there is not enough information to determine if the stock is overpriced or underpriced, the answer would be B. there is not enough information to determine if the stock is overpriced or underpriced.
If the stock is underpriced, meaning it is selling for less than its intrinsic value, the answer would be C. underpriced.
If the stock is overpriced, meaning it is selling for more than its intrinsic value, the answer would be D. overpriced.
To determine the correct answer, we need to compare the calculated intrinsic value of 54.50.
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