An investor with a required return of 14 percent for very risky

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

Firm      A     B     C
Current Earnings     $2.00     $3.20     $7.00
Current dividend     $1.00     $3.00     $7.50
Expected annual growth in dividends and earnings     7%     2%     -1%
Current market price     $23     $47     $60

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

b. If the investor does buy 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 for each stock? Would your answers be different if the appropriate P/E were 7?

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

TUTORIAL PREVIEW

Price = EPS x PE

A         2 x 12 = 24

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