Concept explainers
Two-stage DCF model* 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% a year forever.
- c. Stock C is expected to pay a dividend of $5 next year. Thereafter, dividend growth is expected to be 20% a year for five years (i.e., years 2 through 6) and zero thereafter.
If the market capitalization rate for each stock is 10%, which stock is the most valuable? What if the capitalization rate is 7%?
To determine: The more valuable stock if market capitalization rate is 10% and 7%.
Explanation of Solution
Compute price of the each stocks:
If market capitalization rate is 10%
Therefore, stock C has the largest present value.
Compute price of the each stocks:
If market capitalization rate is 7%
Therefore, stock B has the largest present value at a 7% market capitalization rate.
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Chapter 4 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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