question archive Consider the following three stocks (of the same risk class): Stock A is expected to provide a dividend of €10 a share forever

Consider the following three stocks (of the same risk class): Stock A is expected to provide a dividend of €10 a share forever

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Consider the following three stocks (of the same risk class): Stock A is expected to provide a dividend of €10 a share forever. Stock B is expected to pay a dividend of €5 next year. Thereafter, dividend growth is ex- pected to be 4 percent a year forever. Stock C is expected to pay a dividend of €5 next year. Thereafter, dividend growth is ex- pected to be 20 percent a year for 5 years (i.e., until year 6) and zero thereafter. a) Which stock is the most valuable if the market capitalization rate for each stock is 10 percent? b) What if the opportunity cost of capital is 7 percent?

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1.
Stock A=10/10%=100.0000

Stock B=5/(10%-4%)=83.3333

Stock C=5/1.1+5/1.1*(1.2/1.1)+5/1.1*(1.2/1.1)^2+5/1.1*(1.2/1.1)^3+5/1.1*(1.2/1.1)^4+5/1.1*(1.2/1.1)^5+5/1.1*(1.2/1.1)^5*1/(10%-0%)=104.5051

Stock C is the most valuable stock

2.
Stock A=10/7%=142.8571

Stock B=5/(7%-4%)=166.6667

Stock C=5/1.07+5/1.07*(1.2/1.07)+5/1.07*(1.2/1.07)^2+5/1.07*(1.2/1.07)^3+5/1.07*(1.2/1.07)^4+5/1.07*(1.2/1.07)^5+5/1.07*(1.2/1.07)^5*1/(7%-0%)=156.4987

Stock B is the most valuable stock