Question 3:

a. As a stock analyst for a stockbroking firm, you are looking for undervalued securities. After searching the market, you identify Stock A and Stock B as potential purchases. Stock A is currently selling at $100 with an expected dividend of $6 and constant growth rate of 5%, while Stock B is a growth stock, currently selling at $60 with a dividend of $5 paid each year.

Answer the following questions on the basis that you believe the required rates of return for both stocks should be 10%:

1. How much would you pay for Stock A?

2. How much would you pay for Stock B?

3. Which of the stock is undervalued? Provide your justification.

b. McDermott Roofing Incs common stock paid a dividend of $1.20 per share last year. The company expects earnings and dividends to grow at a rate of 5% per year for the foreseeable future. If you are a shareholder, you want to know the following:

1. What required rate of return for this stock would result in a price per share of $28.

2. If McDermott had both earnings growth and dividend growth at a rate of 10%, what required rate of return would result in a price per share of $28.

c. Isetan Singapore Limited sells common stock for $18.00 a share and has a market rate of return of 5.0 percent. The company just paid an annual dividend of $0.40 per share. As an investors relation executive of Isetan, you are required to:

i. Calculate the dividend growth rate.