Question

Lollipop, Inc., is expected to grow at a constant rate of 9 percent. The company will pay a dividend of $2.75 next year and the current price of the stock is $37.35. If investors require a return of 18% on similar stocks, how much is the stock worth and is it a good buy?a. No, it is not a good buy because the stock is worth $30.56b. Yes, it is a good buy because the stock is worth 37.35c. No, it is not a good buy because the stock is worth $9.50d. None of the above

Answer 1

Answer: a. No, it is not a good buy because the stock is worth $30.56

Explanation:

Using the Gordon Growth model, the value of the stock is;

Value = Next Dividend / ( Required return - growth rate)

= 2.75 / (18% - 9%)

= $30.56

The stock is worth $30.56 yet it is selling for $37.35. It is therefore overvalued and not a good buy.