A. What are the 2 markets where stocks can be purchased? Do you want to buy shar

Question

A. What are the 2 markets where stocks can be purchased? Do you want to buy shares that have never been owned by someone else, or do you want to buy already outstanding shares? What exactly does this mean? What is an IPO?

B. You are interested in buying a share of stock in CAD Corporation. You expect a dividend payment of $0.50 next year and that the dividend will grow by 5% per year thereafter. You desire a 10% return on your purchase. According to the Gordon growth model, what is the maximum price you would pay for a share of this stock? Please show your work.

Explanation / Answer

Q) A. There are primary market and secondary market. If shares are not owned by someone else, such purchasing is done from company; it means a company is issuing shares in the market, which are now owned by public; this is the feature of primary market. If shares are already outstanding of a company, such purchasing is done from stock market; it means those shares are already owned by public and they want to sell those shares; this is the feature of secondary market.

Initial public offering (IPO): This is the primary issue of equity shares to public by any public company. Since the offering is made first time by that company, it becomes an initial.

Q) B. This is intrinsic value calculation.

Maximum price = D1 / (K – g)

Where, dividend in the next year = D1 = $0.50; desire return = K = 0.10; growth rate of dividend = g = 0.05.

Maximum price = D1 / (K – g)

                           = $0.50 / (0.10 – 0.05)

                           = 0.50 / 0.05

                           = $10 (Answer)

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