Question

You are offered two stocks, but aren’t sure if quoted the prices are reasonable. So you decide to determine the fair price of both given some additional information you found.

Stock name: A

Dividend: 4.75$

initial growth: 2%

Later growth: 2% forever

Stock name: B

Dividend: 4.75$

initial growth: 4% annually for the next 8 years (years 2-9)

later growth: flat thereafter (DIV10 = DIV9) forever

Your assumed annual discount rate is 11%.

What is the price of stock Z?

A. $60.37

B. $55.43

C. $51.33

D. $49.84

E. $49.06

Answer 1

THE PRICE OF STOCK IS THE PRESENT VALUE OF ALL DIVIDEND RECEIVED FROM IT.

STOCK A
PRICE = DIV (1+g) / r-g
4.75 x (1+0.02) / (.11-.02)
53.83333333
STOCK B
YR	CF	DF 11%	PV
1	4.75	0.901	4.27975
2	4.94	0.812	4.01128
3	5.14	0.731	3.75734
4	5.35	0.659	3.52565
5	5.56	0.593	3.29708
6	5.78	0.535	3.0923
7	6.01	0.482	2.89682
8	6.25	0.434	2.7125
9	6.5	0.391	2.5415
10 TO INFINITY	6.5	3.554545	23.10455
			53.21877