The current market price of Chuck E Cheese is $92. Andre is very indecisive and therefore missed the annual dividend of $2.50/share that was paid this morning. The required return is 11% and the dividends are projected to grow at a rate of 7%.

Andre should not buy the stock today, even if they just missed the annual dividend.

Question

The current market price of Chuck E Cheese is $92. Andre is very indecisive and therefore missed the annual dividend of $2.50/share that was paid this morning. The required return is 11% and the dividends are projected to grow at a rate of 7%.

Andre should not buy the stock today, even if they just missed the annual dividend.

BlackTom AI · Accepted Answer

Using the Gordon Growth Model for a perpetuity of growing dividends gives the correct benchmark for intrinsic value when dividends grow at a constant rate.

1) Relevant concepts
- Gordon Growth Model: P0 = D1 / (r − g), where D1 is next year’s dividend, r is the required return, and g is the constant growth rate (requires r > g).
- Ex-dividend timing: The dividend paid this morning is D0. The market price quoted after the dividend reflects the stock ex-dividend.

2) Step-by-step reasoning
- The dividend paid today is D0 = $2.50. The next dividend (D1) will grow by g = 7%:
  D1 = D0 × (1 + g) = 2.50 × 1.07 = 2.675.
- Apply the Gordon Growth Model with r = 11% (0.11) and g = 7% (0.07):
  P0 = D1 / (r − g).

3) Intermediate calculations
- r − g = 0.11 − 0.07 = 0.04.
- P0 = 2.675 / 0.04 = 66.875 (or $66.88 rounded).

4) Why the correct answer is correct
- The intrinsic (fair) ex-dividend price implied by future dividends is about $66.88. The current market price is $92 (after the dividend was paid). Since $92 > $66.88, the stock is overpriced relative to its value based on the dividend growth model. Missing today’s dividend does not make the future dividend stream any more valuable; the decision should be based on the present value of future dividends, which shows the stock is overvalued. Therefore Andre should not buy the stock today.

5) Why the other option (buy / False) is incorrect
- The assertion that Andre should buy (i.e., the statement is False) would require the market price to be below intrinsic value. It is not: $92 exceeds the model value $66.88. Even if one considered the price before the dividend (add $2.50 to $92 to get $94.50), that pre-dividend price is still far above intrinsic value. Any reasoning that buying despite missing the dividend makes it attractive ignores the overvaluation implied by the model.

6) Conclusion
- The correct conclusion is True: Andre should not buy the stock today. This matches the provided answer: True.

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