You are faced with opportunity to invest in one of two stocks. Stock A is currently...

You are faced with opportunity to invest in one of two stocks. Stock A is currently selling for $35 and Stock B is currently selling for $25. You have the following information about these companies:

- Stock A just paid a dividend of $1.20 and expects to grow at 10% for 5 years and at 5% after that in perpetuity. It has a required return of 9%

- Stock B is a more well-established company and as such it is predicted that its dividends will grow at 4% in perpetuity. It just paid a dividend of $0.80 per share and has a required return of 7%.

A. What are the dividends for the next 5 years for both companies?

B. Using the dividend discount model (DDM), calculate the value of each share?

C. What would the perpetual growth rate for each company have to be in order for the value as calculated by the DDM to be equal to the current share price?

D. What do you see as the major disadvantage of the DDM? Do you think this disadvantage is made worse by the current effects of COVID19?

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Expert Solution

ekkarill92 answered 1 year ago

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