13. Three investors agree on what a stock\'s next dividend will be and its growt

Question

13. Three investors agree on what a stock's next dividend will be and its growth rate, but are basing their required returns on economic projections and have assigned probabilities to the returns they want under three economic conditions. The probabilities for each return for each investor are listed below. Rank the price of the stock, from highest to lowest, each investor would be willing to pay based on their expected required return a. b. c. Investor 1: Investor 2: Investor 3: 22% for a 20% return: 58% for a 14% return: 20% for a 12% return 20% for a 19% return; 54% for a 15% return; 26% for a 9% return 15% for a 22% return; 45% for a 15% return; 40% for a 5% return

Explanation / Answer

Expected required return of Investor 1= 22% * 20% + 58% *14% + 20% *12%

= 0.22 * 0.20 + 0.58 *0.14 + 0.20 *0.12 = 0.1492 or 14.92%

Expected required return of Investor 2 = 20% * 19% + 54% *15% + 26% *9%

= 0.20 * 0.19 + 0.54 *0.15 + 0.26 *0.09 = 0.1424 or 14.24%

Expected required return of Investor 3 = 15% * 22% + 45% *15% + 40% *5%

= 0.15 * 0.22 + 0.45 *0.15 + 0.40 *0.05 = 0.1205 or 12.05%

The investor with lowest expected required return will be ready to pay highest price for stock because expected required return of Investor used as discounting rate to calculate the price of stock.

Rank the price of stock from highest to lowest for each investor

Investor

Rank (highest stock price to lowest)

Investor 3

1

Investor 2

2

Investor 1

3

Investor

Rank (highest stock price to lowest)

Investor 3

1

Investor 2

2

Investor 1

3

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