Question

Fake Company Epsilon's leadership team members believe the proper required return for their stock is actually around 6.5%. In fact, they have promoted that view to investors for several months. If they are right, and if their dividend is that same $2.35, what does this imply the price of the company's stock should be?

(A) $36.15
(B) $15.28
(C) $22.53

Answer 1

Using the dividend discount model with a dividend of $2.35 and a required return of 6.5%, the implied stock price for Fake Company Epsilon is (Option A) $36.15.

Step-by-step explanation:

If Fake Company Epsilon's leadership team believes that the proper required return for their stock is around 6.5% and the dividend is $2.35, we can use the dividend discount model (DDM) to calculate the stock price. The DDM is a procedure for valuing the price of a stock by using predicted dividends and discounting them back to present value. The formula to calculate the price of the stock is:

Price = Dividend per share / Required Rate of Return

If we apply the values we have:

Price = $2.35 / 0.065

The calculated price of the stock would be:

Price = $36.15

Therefore, the implied price of the company's stock would be $36.15, which corresponds to option (A).