ST-2.

dividend $3 25

a. expected return = = --'- = 0.0844 = 8.44%

market price $38.50

b. Given your 8 percent required rate of return, the stock is worth $40.62 to you:

value = dividend = $3.25 = $40.62 required rate of return 0.08 Because the expected rate of return (8.44%) is greater than your required rate of return (8%) or because the current market price ($38.50) is less than $40.62, the stock is undervalued and you should buy.