Question

Consider the following three stocks:

1. Stock A is expected to provide a dividend of $10.80 a share forever.
2. Stock B is expected to pay a dividend of $5.80 next year. Thereafter, dividend growth is expected to be 3.00% a year forever.
3. Stock C is expected to pay a dividend of $5.80 next year. Thereafter, dividend growth is expected to be 19.00% a year for five years (i.e., years 2 through 6) and zero thereafter.

a-1. If the market capitalization rate for each stock is 9.00%, what is the stock price for each of the stocks? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

a-2. Which stock is the most valuable?

• Stock A

• Stock B

• Stock C

b-1. If the market capitalization rate for each stock is 6.00%, what is the stock price for each of the stocks? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

b-2. Which stock is the most valuable?

• Stock B

• Stock C

• Stock A

Answer 1

a-1 . Value of Stock A =Dividend /Rate =10.80/9% =120
Value of Stock B =Dividend Next Year/(Required Rate-Growth) =5.80/(9%-3%)=96.67
For Stock C
D1=5.8
D2=5.8*1.19
D3=5.8*1.19^2
​​​​​​​D4=5.8*1.19^3
​​​​​​​D5=5.8*1.19^4
​​​​​​​D6=5.8*1.19^5
Terminal Value at year 6 =D7/Required Rate =5.8*1.19^5/9% =153.7872
Price of Stock C=5.8/1.09+5.8*1.19/1.09^2+5.8*1.19^2/1.09^3+5.8*1.19^3/1.09^4+5.8*1.19^4/1.09^5+5.8*1.19^5/1.09^6+153.7872/1.09^6
=131.91
Stock C is most valuable

b-1. Value of Stock A =Dividend /Rate =10.80/6% =180
Value of Stock B =Dividend Next Year/(Required Rate-Growth) =5.80/(6%-3%)=193.33
For Stock C
D1=5.8
D2=5.8*1.19
​​​​​​​D3=5.8*1.19^2
​​​​​​​D4=5.8*1.19^3
​​​​​​​D5=5.8*1.19^4
​​​​​​​D6=5.8*1.19^5
Terminal Value at year 6 =D7/Required Rate =5.8*1.19^5/6% =230.6809
Price of Stock C=5.8/1.06+5.8*1.19/1.06^2+5.8*1.19^2/1.06^3+5.8*1.19^3/1.06^4+5.8*1.19^4/1.06^5+5.8*1.19^5/1.06^6+230.6809/1.06^6
=207.32

b-2. Stock C is most valuable stock