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Stock Price / Cost of debt and equity

Two investors are evaluating GE's stock for possible purchase. They agree on the expected value of D1 and on the expected future growth rate. Further, they agree on the riskiness of the stock. However, one investor normally holds stock for 2 years, while the other holds stock for 10 years. Should they both be willing to pay the same price for GE's stock? Explain.

Assume the risk-free rate increases. What impact would this have on the cost of debt? What impact would it have a cost of equity?

Solution Preview

Two investors are evaluating GE's stock for possible purchase. They agree on the expected value of D1 and on the expected future growth rate. Further, they agree on the riskiness of the stock. However, one investor normally holds stock for 2 years, while the other holds stock for 10 years. Should they both be willing to pay the same price for GE's stock? Explain.

Yes, they should be willing to pay the same price. The price of the stock is the present value of all dividends. Since the growth rate is constant, the present value of all dividends would be
Price = D1/(Required ...

Solution Summary

The solution explains the impact on stock price for different holding periods and the impact of change in risk free rate on cost of debt and cost of equity

$2.19