Question

Which assertion about the prices of stocks Kilo, Lima, Mike, and November is true? All 4...

Which assertion about the prices of stocks Kilo, Lima, Mike, and November is true? All 4 stocks pay annual dividends with the next dividend expected 1 year. The next expected dividend for stocks Kilo and Mike are expected to be different, as DM > DK > 0, and the next expected dividend for stocks November and Lima are expected to be the same. The dividends for each stock are expected to grow at a constant rate of G forever. The expected returns for stocks November and Lima are expected to be different, as RN > RL > 0, and the expected returns for stocks Kilo and Lima are expected to be the same. Finally, D > 0, R > 0, and G > 0.

A.

The price of stock Kilo is greater than the price of stock Mike and the price of stock Lima is greater than the price of stock November.
B.

Answer not listed or not possible.
C.

The price of stock Mike is greater than the price of stock Kilo and the price of stock November is greater than the price of stock Lima.
D.

The price of stock Kilo is greater than the price of stock Mike and the price of stock November is greater than the price of stock Lima.
E.

The price of stock Mike is greater than the price of stock Kilo and the price of stock Lima is greater than the price of stock November.
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Homework Answers

Answer #1

From Gordon's Zero growth model,

P0 = D1/ r

Here, the price of stock is directly related to Dividends and inversely related to their required rates r

Hence, from the given information

Since, RN>RL and the DN=DL

So, it follows that the Price of November must be less than the price of Lima

However, last piece of information is that expected returns for stocks Kilo and Lima are expected to be the same. But there is no other comparison between Dividends of Kilo and Lima. Similarly for Kilo and Mike, there is no comparison provided for their expected rates. So, there is no other inference that can be drawn from the given information

Hence, OPTION B is the correct answer  

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