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(Solution document) An investor with a required return o 14% for very risky investments in common stock has analyzed 3 firms and must decide which, if any, to purchase....


An investor with a required return o 14% for very risky investments in common stock has analyzed 3 firms and must decide which, if any, to purchase. The information is as follows:

Firm A

Current earnings $2

Current dividend $1

Expected annual growth rate in dividends and earnings 7%

Current market price $23


Firm B

Current earnings $3.20

Current dividend $3

Expected annual growth rate in dividends and earnings 2%

Current market price $47


Firm C

Current earnings $7

Current dividend $7.50

Expected annual growth rate in dividends and earnings -1%

Current market price $60


Question

a.What is the maximum price that the investor should pay for each stock based on the dividend-growth model?

b. If the investor buys stock A, what is the implied percentage return?

c. If the appropriate P/E ratio is 12, what is the maximum price the investor should pay or each stock? Would the answer be different if the appropriate P/E were 7?

d. What does stock C's negative growth rate imply?

 







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