Question

Common stock valuation) Wayne, Inc.'s outstanding common stock is currently selling in the market for $30. Dividends of $3.28 per share were paid last year, return on equity is 23 percent, and its retention rate is 25 percent.

a. What is the value of the stock to you, given a required rate of return of 16 percent?
b. Should you purchase this stock?

Answer 1

The value of the stock is $36.55 given a required rate of return of 16%. It is important to consider other factors before deciding whether to purchase the stock.

Step-by-step explanation:

To calculate the value of the stock, we can use the dividend discount model (DDM) formula:
V0 = D1 / (k - g), where V0 is the stock value, D1 is the dividend expected to be received next year, k is the required rate of return, and g is the dividend growth rate.
Given that dividends of $3.28 were paid last year, the growth rate (g) can be calculated as the product of the return on equity (ROE) and the retention rate: g = ROE * Retention rate.
Plug in the given values into the formula and we get: V0 = 3.28 / (0.16 - (0.23 * 0.25)) = $36.55.

To determine whether to purchase the stock, compare the calculated value of $36.55 to the current market price of $30. If the calculated value is higher, the stock may be undervalued and it could be a good investment. However, further analysis and consideration of other factors is recommended before making a final decision.