Each of two stocks,A and B,are expected to pay a dividend of $7 in the upcoming year.The expected growth rate of dividends is 6% for both stocks.You require a return of 10% on stock A and a return of 12% on stock B. Using the constant growth DDM, the intrinsic value of stock A _________.

Question

Quizplus · Accepted Answer

The intrinsic value of a stock using the constant growth DDM formula is:

Intrinsic value = Dividend / (Required rate of return - Growth rate)

For stock A:
Intrinsic value = 7 / (0.1 - 0.06) = $175

For stock B:
Intrinsic value = 7 / (0.12 - 0.06) = $58.33

Since the intrinsic value of stock A is higher than that of stock B, the answer is A, i.e. the intrinsic value of stock A will be higher than the intrinsic value of stock B.

Each of Two Stocks,A and B,are Expected to Pay a Dividend