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An investor with a required return of 14 percent for very risky investments in common

An investor with a required return of 14 percent for very risky investments in common stock has analyzed three firms and must decide which, if any, to purchase. The information is as follows: Firm

Firm                                                                                 A                                       B                                   C


Current Earnings                                                     $2.00                              $3.20                          $7.00


Current dividend                                                     $1.00                              $3.00                          $7.50


Expected annual growth in


dividends and earnings                                        7%                                     2%                              -1%


Current market price                                           $23                                   $47                             $60

(a) What is the maximum price that the investor should pay for each stock based on the dividend-growth model?

(b) If the investor does buy stock A, what is the implied percentage return?

(c) If the appropriate P/E ratio is 12, what is the maximum price the investor should pay for each stock? Would your answers be different if the appropriate P/Ewere 7?

(d) What does stock C's negative growth rate imply?

May 11 2018 Read more Less More

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