Scenario: Chase and I are looking at Publix's stock because we are both very wealthy stock market investors. We agree on the expected dividend Publix will be paying. Chase has come up with an ironclad formula for projecting future dividend growth. He has franchised this information and made over $50 million on the formula in the last four years. We also agree on the level of risk for the stock (I had to buy this formula from Chase). I hold my stock for two years because of my advancing age. Chase holds his stocks for 10 years (because he is younger).
The question is, should we or should we not pay the same price for the stock? Why or why not?
Please refer to the attached file for the response.
REQUIRED RATE OF RETURN, GROWTH, AND VALUE OF STOCKS
Investment Objective: To have a higher value of stock (value of the stock) for the year to come (Year 1) than that of another investor.
Both will receive a dividend of $10 in year
Problem: Should the investor ...
This solution provides calculations for valuing the common stock at market price. This solution concludes that, in order to achieve the objective of a higher value of the stock for the coming year, the investor should pay a higher price. The same conclusion will not change at an assumed growth rate (e.g. 2%) because same growth rate will have the same effect on required rate of return for both investors.