I worked this problem out and need confirmation that the responses to parts A and B are correct. For part C, I need help in outlining how one might interpret the difference.

P725 Ethics Problem Melissa is trying to value the stock of Generic Utility Inc., which is clearly not growing at all. Generic declared and paid a $5 dividend last year. The required return for utility stocks is 11%, but Melissa is unsure about the financial reporting integrity of Generics finance team. She decides to add an extra 1% credibility risk premium to the required return as part of her valuation analysis.

Part A.

What is the value of Generics stock, assuming that the financials are trustworthy?

Assuming the financials are trustworthy, current stock price equals the last dividend divided by the required rate of return

=$5/$11%

=5/0.11

=$45.45

Part B.

What is the value of Generics stock, assuming that Melissa includes the extra 1% credibility risk premium?

Assuming Melissa includes the extra 1% credibility risk premium the value of the stock would be determined by dividing the dividend by the rate of return

=$5/$12%

=5/0.12

=$41.67

Part C.

What is the difference between the values found in parts a and b, and how might one interpret that difference?

The difference between the two values is $3.78. This is the result of the investors' perceived risk of owning the stock. In this case, the company may not have the funds available to pay the preferred dividend.