Question

you are considering investing in B&B Inc's stock and your broker has told you that you can purchase it for $72. you require a return 12% for this type of investment. the last dividend (Do) that B&B paid was $4 and a 6% constant growth rate is anticipated. should you purchase B&B inc.?

Answer 1

To determine whether you should purchase B&B Inc.'s stock, you need to calculate the intrinsic value of the stock using the dividend discount model (DDM). The calculated intrinsic value is $4, but the current price of the stock is $72, so it is not advisable to purchase B&B Inc.'s stock.

Step-by-step explanation:

To determine whether you should purchase B&B Inc.'s stock, you need to calculate the intrinsic value of the stock using the dividend discount model (DDM).

1. First, calculate the expected dividend in the next year (D1) by multiplying the last dividend (Do) by the growth rate (g). In this case, D1 = $4 * 6% = $0.24.
2. Next, calculate the intrinsic value (V) of the stock using the formula: V = D1 / (r - g), where r is the required return rate. In this case, r = 12%.
3. Substituting the values, V = $0.24 / (0.12 - 0.06) = $4.00.

Since the current price of the stock is $72, which is higher than the calculated intrinsic value of $4, it is not advisable to purchase B&B Inc.'s stock.