You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for stock D. The intrinsic value of stock C
A) will be greater than the intrinsic value of stock D.
B) will be the same as the intrinsic value of stock D.
C) will be less than the intrinsic value of stock D.
D) will be the same or greater than the intrinsic value of stock D.
E) None of the options are correct.

Question

Quizplus · Accepted Answer

The intrinsic value of a stock can be calculated using the Gordon Growth Model, which is $ P = \frac{D}{r - g} $, where $ P $ is the price (or intrinsic value), $ D $ is the dividend, $ r $ is the required rate of return, and $ g $ is the growth rate. For stock C, the growth rate is lower than for stock D (9% vs. 10%), but both have the same required rate of return and dividend. Therefore, the denominator ($ r - g $) for stock C will be larger than for stock D, resulting in a lower intrinsic value for stock C compared to stock D.

You Wish to Earn a Return of 10% on Each