A person is considering buying the stock of two home health companies that are s

Question

A person is considering buying the stock of two home health companies that are similar in all respects except the proportion of earnings paid out as dividends. Both companies are expected to earn $6 per share in the coming year, but Company D(for dividends) is expected to pay out the entire amount as dividens, while Company G (for growth) is expected to pay out only one third of its earnings or $2 per share. The companies are equally risky and their requred rate of return is 1%. D's constant growth rate is zero and G's is 8.33%. What are the intrinsic values of stocks D and G ?

Explanation / Answer

For company D,

PV of all dividends = Annual Dividends/Required return
= 6/1%
= $600
The intrinsic value is $600

For company G,

Intrinsic value = D1/(Required return – Growth rate)

D1 = expected dividend = $2

Required return = 1%

and growth rate = 8.33%

So u can calculate the Intrinsic value using the formula

but it cant b negative so i think there is some misprint in given data

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