Explanation

This is a two-stage dividend discount model (DDM) problem. We need to calculate the intrinsic value and compare it to the current price.

Step 1: Calculate dividends for the first 3 years

• D₁ = $2.00 × (1 + 20%) = $2.40
• D₂ = $2.40 × (1 + 20%) = $2.88
• D₃ = $2.88 × (1 + 20%) = $3.456

Step 2: Calculate terminal value at the end of year 3 \text{Terminal Value} = \frac{D_4}{r - g} = \frac{3.456 \times (1 + 6\%)}{17\% - 6\%} = \frac{3.663}{0.11} = \`$33.30`

Step 3: Calculate present value of all cash flows $\text{Intrinsic Value} = \frac{2.40}{(1.17)^1} + \frac{2.88}{(1.17)^2} + \frac{3.456}{(1.17)^3} + \frac{33.30}{(1.17)^3}$ $= \frac{2.40}{1.17} + \frac{2.88}{1.3689} + \frac{3.456}{1.6016} + \frac{33.30}{1.6016}$ = 2.051 + 2.104 + 2.158 + 20.79 = \`$27.10`

Step 4: Compare with current price

• Intrinsic Value = $27.10
• Current Price = $31.00
• The stock is trading above its intrinsic value

Step 5: Apply the +/- 10% band

• Fair value range: $27.10 × 0.90 to $27.10 × 1.10 = $24.39 to $29.81
• Current price ($31.00) is above the upper bound of the fair value range

Therefore, the stock is overvalued and the correct answer is C.