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Schmendiman, Inc., is the sole manufacturer of schmedimite (an inflexible, brittle building material made of radium and asbestos). Assume that the company's common stock can be valued using the constant dividend growth model (also sometimes known as the "Gordon Dividend Growth Model"). You expect that the return on the market will be 14 percent and the risk-free rate is 6 percent. You have estimated that the dividend one year from now will be $3.40, the dividend will grow at a constant 6 percent, and the stock's beta is 1.50. The common stock is currently selling for $30.00 per share in the marketplace.
a. What value would you place on one share of this company's common stock (based on a thorough understanding of Chapter 5 in the book)?
b. Is the company's common stock overpriced, underpriced, or fairly priced? Why?
The firm is considering switching to a 20-percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt.
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