As an investor you have a required return of 14% for investments in common stock

Question

As an investor you have a required return of 14% for investments in common stocks. You have analyzed three firms and must decide which stock(if any) to purchase. Your information is as follows:

FIRM

A

B

C

Current DIVIDENDS

1.00

3.00

7.5

EXEPECTED ANNIAL GROWTH RATE IN DIVIDENDS(AND EARNINGS)

Same as 10 years growth when dividends were $0.5

2%                               

-1%

CURRENT MARKET PRICE OF THE STOCKS

$23

$47

$60

Using the Dividend Growth Model: V= D(1+g)/K-G:

a.What is the maximum price that you should pay for each stock? Which stock should you purchase(if any)?

b.If you purchased Firm A stock, what would your implied required rate of return?

c.If your required rate of return was 10%, what would be the price necessary to induce you to buy stock A?

FIRM

A

B

C

Current DIVIDENDS

1.00

3.00

7.5

EXEPECTED ANNIAL GROWTH RATE IN DIVIDENDS(AND EARNINGS)

Same as 10 years growth when dividends were $0.5

2%                               

-1%

CURRENT MARKET PRICE OF THE STOCKS

$23

$47

$60

Explanation / Answer

A

Stock A

Let the growth be

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