Question

Danny is considering a stock purchase. The stock pays constant annual dividends of ​$1.54 per share and is currently trading at ​$21.27. ​Danny's required rate of return for this stock is 14.1​%. Should he buy this​ stock?

Answer 1

Answer:

No he should not buy this stock.

Explanation:

The stock pays a constant dividend thus it means it is a zero growth stock. The formula to calculate the fair price of a zero dividend growth stock is as follows,

• P = D / k

• Where D represents dividend
• k represents required rate of return
• P = 1.54 / 0.141 = 10.92

The fair price of the stock according to the Dividend discount model is 10.92 while the stock is trading at 21.27 which means that the stock is overpriced. So, it should not be purchased.