BACKGROUND INFO:

Gianna Peters is an investment analyst who focuses on dividend-paying stocks. Peter uses a discounted cash flow (DCF) approach to stock selection. She is getting with her staff to evaluate portfolio holdings based on a bottom-up screening of stocks listed in the United States and Canada. Peters and her staff begin reviewing the characteristics of the following portfolio candidates.

Company ABC

A Canadian company in the customer staples sector with a required rate of return of 7.35%. Recent media reports suggest that ABC might be a takeover candidate. Peters and her team estimate that if the incumbent Canadian prime minister's party retains its power, the company's current annual dividend of C$0.65 per share will grow 12% a year for the next four years and the stabilize to 3.5% growth rate a year indefinitely. However, if a new government takes office in Canada, then the team estimates that ABC will likely not experience the elevated 12% short-run growth because of new regulatory and tax changes, and instead will grow by 3.5 indefinitely.

Company XYZ

A mid sized US company in the utilities sector with a required rate of return of 10%. Peters and her team believe that because of a recent restructuring, the company is unlikely to pay dividends for the next three years. However, the team expects XYZ to pay an annual dividend of US $1.72 per share beginning four years from now. Thereafter, the dividend is expected to grow indefinitely at 4% even though the current price implies a growth rate of 6% during this same period.

Company JZY

A large US company in the telecom sector with a required rate of return of 8%. The stock is currently trading at US$36.76 per share with an implied earnings growth rate of 3.5%. Peters believes that because JZY is mature and has a stable capital structure, the company will grow at its sustainable growth rate. Over the past 10 years, the company's return on equity (ROE) has averaged 8.17% and its payout ratio has averaged 40%. Recently, the company paid an annual dividend of US$0.84 per share.

Peters asks the team to examine the growth opportunities of three Canadian stocks currently held in the portfolio. These stocks are listed below:

STOCK	REQUIRED RATE OF RETURN	NEXT YRS FORECASTED EPS (C$)	CURRENTPRICEPERSHARE(C$)
ABTD	10.5%	7.30	80.00
BKKQ	8%	2.12	39.00
CPMN	12%	1.90	27.39

QUESTIONS:

1. If the team uses the dividend discount model, the current intrinsic value of Company XYZ stock would be closest to:

A. US$19.58

B. US$20.36

C. US$21.54

2. The dividend growth rate implied in the stock price of Company XYZ suggests that XYZ's stock price is most likely:

A. undervalued

B. fairly valued

C. overvalued

3. Based on the relationship between the implied growth rate and the sustainable growth rate, Peters' team should conclude that company JZY's stock price is most likely:

A. undervalued

B. fairly valued

C. overvalued