Question

The board of directors of API, a relatively new electronics manufacturer, has decided to continue paying a common stock dividend to increase the attractiveness of the stock in the free market. The board plans to pay $3.00 per share in the coming year (i.e., next year) and anticipates that its future dividends will increase at an annual rate consistent with that experienced over the period from 20X0 - 20X3 (see below). The company currently has a beta of 1.1, the rate of return for the market is expected to be 10% and the risk-free rate is currently 4%. Given this scenario, what is the current value of API's common stock? If the current market price is $40.00 per share, should you purchase this stock? Briefly, explain your answer.

Year Dividend
20X3 $2.81
20X2 $2.70
20X1 $2.60
20X0 $2.50

Answer 1

API, an electronics manufacturer, plans to pay a dividend of $3.00 per share next year and expects future dividends to grow at a rate similar to the average growth rate from 20X0 to 20X3. The company has a beta of 1.1, the market return is projected at 10%, and the risk-free rate is 4%. Using the dividend discount model, the current value of API's stock is estimated to be around $85.71 per share. Since the market price is currently $40.00 per share, the stock appears to be undervalued, and it could be a potentially good investment opportunity. However, further analysis should be conducted before making any investment decisions.

Explanation: