Asked by Alexandra Rosen on Apr 28, 2024
Verified
You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for 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) will be the same or greater than the intrinsic value of stock D.
E) None of the options are correct.
Expected Growth Rate
Represents the anticipated annual rate at which an investment, company, or economy will grow over a specified period.
Rate of Return
The gain or loss of an investment over a specific period, expressed as a percentage of the investment's initial cost.
Dividend
A portion of a company's earnings distributed to its shareholders, usually in the form of cash or stock.
- Investigate the link between stock values considering both consistent and variable rates of dividend growth.
Verified Answer
ZK
Zybrea KnightMay 04, 2024
Final Answer :
C
Explanation :
The intrinsic value of a stock can be calculated using the Gordon Growth Model, which is P=Dr−g P = \frac{D}{r - g} P=r−gD , where P P P is the price (or 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, the growth rate is lower than for stock D (9% vs. 10%), but both have the same required rate of return and dividend. Therefore, the denominator ( r−g r - g r−g ) for stock C will be larger than for stock D, resulting in a lower intrinsic value for stock C compared to stock D.
Learning Objectives
- Investigate the link between stock values considering both consistent and variable rates of dividend growth.