Question

Two investors are evaluating Honewell’s common stock for possible purchase. They agree on the expected value of D1 and also on the expected future dividend growth rate. Further, they agree on the riskiness of the stock, and thus, the discount rate. Assume that the first investor would plan to sell the stock after 3 years and the 2nd investor would plan on selling the stock after 5 years. Would they agree on the price of the stock today, or would they disagree on the price because of the differences in the length of time that each plans to hold the stock? Clearly explain.

Answer 1

Yes, they will be agreeing on the price of the stock today because when we are calculating the price of this share according to the dividend discount model, then we are not providing any preference to the date of selling of the shares by the investor and hence we can say that even if there will be a difference in the date of selling of the shares by the investor, the price which has been paid today for acquisition of those shares will not make any difference because they are agreeing upon the discount rate as well as the rate of growth of the dividend.

when we are calculating the price of the stock according to the dividend discount model, then we will be not considering any kind of time duration of holding of the the stock and we will rather be considering the required rate of return along with the growth rate and the dividend and hence we will be trying to do not providing any effect to the the time horizon of investment and hence the price which will be paid by both the investor will be similar in nature.