RobertA

In its most recent quarterly earnings report, Smith Brothers Garden Supplies said it planned to increase its dividend at an annual rate of 5% for the foreseeable future. Analyst Anton Spears is using a required return of 9.5% for Smith Brothers stock. Smith Brothers stock trades for $52.17 per share and earned $3.01 per share over the last 12 months. The company paid a dividend of $2.15 per share during the last 12-month period, and its dividend-growth rate for the last five years was 9.2%. Using the Gordon Growth model, the share price for Smith Brothers stock is most likely:

A) correctly valued.

B) overvalued.

C) undervalued.

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The Gordon Growth model is as follows:
Value = [dividend × (1 + dividend growth rate)] / [required return − growth rate]

Value	= [2.15 × 1.05] / [0.095 − 0.05]
	= 2.2575 / [0.095 − 0.05]
	= 50.17

RobertA

The current market price per share for Burton, Inc. is $33.33, and an analyst is using the Gordon Growth model to determine whether this is a fair price. The company paid a dividend of $2.00 last year on earnings of $2.50 a share. If the required rate of return is 12.00% and the expected grown rate in earnings and in dividends is 6%, the current market price is most likely:

A) correctly valued.

B) undervalued.

C) overvalued.

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The value per share using the estimates is $35.33 = [$2.00(1.06) / 0.12 − 0.06)]. This is higher than the current share price.