Asked by Katrina Kazandjian on Apr 27, 2024
Verified
Each of two stocks, A and B, are expected to pay a dividend of $5 in the upcoming year. The expected growth rate of dividends is 10% for both stocks. You require a rate of return of 11% on stock A and a return of 20% on stock B. The intrinsic value of stock A
A) will be greater than the intrinsic value of stock B.
B) will be the same as the intrinsic value of stock B.
C) will be less than the intrinsic value of stock B.
D) cannot be calculated without knowing the market rate of return.
Expected Growth Rate
The anticipated rate at which an investment, economy, or other financial entity will grow over a certain period.
Rate of Return
The outcome in terms of profit or loss on an investment over a designated period, presented as a percentage of the investment’s first cost.
Dividend
A part of a company’s profits given out to its shareholders, usually as cash or more shares.
- Gauge the core value of stocks by adopting dividend discount procedures.
Verified Answer
AF
amira foudaApr 29, 2024
Final Answer :
A
Explanation :
The intrinsic value of a stock can be calculated using the Gordon Growth Model (Dividend Discount Model for a perpetuity with growth), which is P = D / (r - g), where P is the price (intrinsic value), D is the dividend, r is the required rate of return, and g is the growth rate. For stock A, P = 5 / (0.11 - 0.10) = $500. For stock B, P = 5 / (0.20 - 0.10) = $50. Therefore, the intrinsic value of stock A is greater than the intrinsic value of stock B.
Learning Objectives
- Gauge the core value of stocks by adopting dividend discount procedures.