Each of two stocks, A and B, is 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

Using the constant-growth DDM, the intrinsic value can be calculated as follows: 
For stock A:
Intrinsic value = Dividend / (Required rate of return - Dividend growth rate)
= $7 / (10% - 6%)
= $175
For stock B:
Intrinsic value = Dividend / (Required rate of return - Dividend growth rate)
= $7 / (12% - 6%)
= $116.67
Therefore, the intrinsic value of stock A is higher than the intrinsic value of stock B, so the answer is A.

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