Stark asks Parker to evaluate whether the common stock of Company D is undervalued, fairly valued, or overvalued based on a residual income model. Parker uses the two-stage residual income model to value Company D’s share. For her analysis, she assumes the following:
- Current market price is $24.00.
- Beginning book value per share is $20.00.
- Earnings per share will be 32% of beginning book value for the next year.
- Cash dividends will be 50% of earnings per share for the next year.
- At the end of the year, the stock’s P/B ratio will be 1.1.
- Required rate of return on equity is 10%.
Based on the information given, Parker should conclude that Company D’s share is:
- undervalued.
- fairly valued.
- overvalued.