Explanation:

To determine if the stock is undervalued, fairly valued, or overvalued using the Gordon growth model, we need to calculate the justified P/E ratio and compare it to the actual trailing P/E ratio.

Step 1: Calculate the dividend payout ratio

• Retention rate = 45%
• Dividend payout ratio = 1 - Retention rate = 1 - 0.45 = 0.55 or 55%

Step 2: Calculate the justified trailing P/E ratio using the Gordon growth model The formula for justified trailing P/E is: $\text{Justified P/E} = \frac{\text{Payout ratio} \times (1 + g)}{r - g}$ Where:

• Payout ratio = 0.55
• g = 4.0% = 0.04
• r = 8.8% = 0.088

$\text{Justified P/E} = \frac{0.55 \times (1 + 0.04)}{0.088 - 0.04} = \frac{0.55 \times 1.04}{0.048} = \frac{0.572}{0.048} = 11.92$

Step 3: Compare justified P/E with actual P/E

• Justified P/E = 11.92
• Actual trailing P/E = 13.9

Since the actual P/E (13.9) is higher than the justified P/E (11.92), the stock is overvalued according to the Gordon growth model.

Therefore, the correct answer is C.