Each of two stocks, A and B, are expected to pay a dividend of $5 in the upcoming year. The expected growth rate of dividends is 10% for both stocks. You require a rate of return of 11% on stock A and a return of 20% on stock B. The intrinsic value of stock A
A) will be greater than the intrinsic value of stock B.
B) will be the same as the intrinsic value of stock B.
C) will be less than the intrinsic value of stock B.
D) cannot be calculated without knowing the market rate of return.

Question

Quizplus · Accepted Answer

The intrinsic value of a stock can be calculated using the Gordon Growth Model (Dividend Discount Model for a perpetuity with growth), which is P = D / (r - g), where P is the price (intrinsic value), D is the dividend, r is the required rate of return, and g is the growth rate. For stock A, P = 5 / (0.11 - 0.10) = $500. For stock B, P = 5 / (0.20 - 0.10) = $50. Therefore, the intrinsic value of stock A is greater than the intrinsic value of stock B.

Each of Two Stocks, a and B, Are Expected to Pay