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
E)none of the above is true.

Question

Quizplus · Accepted Answer

To calculate the intrinsic value of a stock using the dividend discount model, we use the formula:
Intrinsic Value = Dividend / (Required Rate of Return - Dividend Growth Rate)
For stock A: 
Intrinsic Value = $5 / (0.11 - 0.10) = $50
For stock B: 
Intrinsic Value = $5 / (0.20 - 0.10) = $50
Since the expected rate of return for stock B is higher than that of stock A, the market is valuing stock B more than stock A. Therefore, the intrinsic value of stock A will be less than the intrinsic value of stock B. Option C is incorrect since the intrinsic value of stock B is $50, which is the same as the intrinsic value of stock A. Option D is also incorrect since we do not need the market rate of return to calculate the intrinsic value using the dividend discount model.

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