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Monica Dubois, an ABC investment advisor, has a new client, Mr. Jack Klein. Mr. Klein is a conservative investor who is interested in a required rate of return of 10% on his stock investments while assuming lower market risk. You are asked to help Monica make a suitable portfolio recommendation backed by risk-return calculations. The 3 possible stock choices for Mr. Klein and their respective betas are as follows:

Stock

Expected Return

Beta

ABC

10%

0.75

XYZ

11%

1.0

WHY

12%

1.25

Part I

Determine the expected returns and beta for a portfolio consisting of one third of Mr. Klein's funds in each stock.

Part II

Assume the following:

Each ABC stock pays current dividends of $1.50 annually with 6% expected annual increases. The current market stock price for

ABC is $30 per share.

Each XYZ stock pays current dividends of $1.75 annually with 6% expected annual increases. The current market stock price for

XYZ is $27 per share.

Each WHY stock pays current dividends of $2.25 annually with 7% expected annual increases. Current market stock price for

WHY is $35 per share.

Complete the following for this assignment:

Using the constant dividend growth model, determine whether ABC and WHY are over- or undervalued.

For what types of companies is the constant growth model an appropriate analysis tool?

What are the limitations of the constant growth model?

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