Asked by lyndsey holder on May 12, 2024
Verified
Each of two stocks, C and D, are expected to pay a dividend of $3 in the upcoming year. The expected growth rate of dividends is 9% for both stocks. You require a rate of return of 10% on stock C and a return of 13% on stock D. The intrinsic value of stock C
A) will be greater than the intrinsic value of stock D.
B) will be the same as the intrinsic value of stock D.
C) will be less than the intrinsic value of stock D.
D) cannot be calculated without knowing the market rate of return.
Expected Growth Rate
The annual rate at which an investment, company revenue, or economy is expected to grow over a future period.
Rate of Return
The achievement or shortfall in value of an investment during an established time, shown as a percentage of the investment’s original financial input.
Dividend
A portion of a company's earnings distributed to shareholders, typically in the form of cash or additional shares.
- Calculate the intrinsic value of stocks using dividend discount models.
Verified Answer
KS
Kelly StringbergMay 16, 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) as P=Dr−g P = \frac{D}{r - g} P=r−gD , where P P P is the price (intrinsic value), D D D is the dividend, r r r is the required rate of return, and g g g is the growth rate. For stock C, PC=30.10−0.09=300 P_C = \frac{3}{0.10 - 0.09} = 300 PC=0.10−0.093=300 , and for stock D, PD=30.13−0.09=75 P_D = \frac{3}{0.13 - 0.09} = 75 PD=0.13−0.093=75 . Therefore, the intrinsic value of stock C is greater than the intrinsic value of stock D.
Learning Objectives
- Calculate the intrinsic value of stocks using dividend discount models.