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Consider the following three stocks:
a. Stock A is expected to provide a dividend of $10 a share forever.
b. Stock B is expected to pay a dividend of $5 next year. Thereafter, dividend growth is expected to be 4 percent a year forever.
c. Stock C is expected to pay a dividend of $5 next year. Thereafter, dividend growth is expected to be 20 percent a year for 5 years (i.e., until year 6) and zero thereafter.
If the market capitalization rate for each stock is 10 percent, which stock is the most valuable? What if the capitalization rate is 7 percent?

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Solution Summary

Finds the most valuable stock for different capitalization rates.

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Consider the following three stocks:
a. Stock A is expected to provide a dividend of $10 a share forever.
b. Stock B is expected to pay a dividend of $5 next year. Thereafter, dividend growth is expected to be 4 percent a year forever.
c. Stock C is expected to pay a dividend of $5 next year. Thereafter, dividend growth is expected to be 20 percent a year for 5 years (i.e., until year 6) and zero thereafter.

If the market capitalization rate for each stock is 10 percent, which stock is the most valuable?

Capitalization rate = 10%

Stock A:
Constant dividend =D= $10.00
Price= D/r= $100.00 =10./10.%

Stock B:

Using the Dividend Discount (Constant Growth) Model
Po= Div1/ (r-g)
Dividend for next year= Div1 = $5.00
Cost of equity= r= 10%
growth rate of dividends/earnings= g= 4.00%
Current stock ...

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