Assume that the risk-free rate of interest is 5% and the expected rate of return on the market is 15%. Stock A is currently selling at $40 per share. The stock is expected to pay $5 dividends next year, and you expect it to sell then for $50 per share. The stock has a beta of 1.25. Is Stock A currently underpriced or overpriced? 

 

b) Assume that the risk-free rate of interest is 5% and the expected rate of return on the market is 15%. The Company of Stock B pays no cash dividend currently and is not expected to for the next 10 years. Its latest EPS (Earnings Per Share) was $5, all of which was reinvested in the company. The firm's expected ROE for the next 10 years is 25% per year. And during this time it is expected to continue to reinvest all of its earnings. The beta of Stock B is 1.0. You have two scenarios:

 

c) If starting in year 11, the firm's ROE on new investment is expected to fall to 20%, and the company is expected to start paying out 50% of its earnings in cash dividends, which it will continue to do forever after. Given the current situation, what is the intrinsic value of Stock B?