Answer: Stock A is expected to provide a dividend of $13.4 a share forever which means it is a perpetuity. The market capitalization is 10% which means that 10% is the required rate of return. The formula to find the value of a perpetuity is Cash Flow/Rate
The cash flow is 13.4 and rate is 10% so 13.4/0.1= $134
The present value of Stock A is $134
Stock B is expected to pay a dividend of $6.7 next year and then have a constant growth rate of 6% forever, so we can find what the present value of Stock B will be next year using the DDM method and then discount that value to this year.
1 year from now dividend = 6.7
Growth = 4%
R= 10%
Formula = D*(1+G)/R-G
= 6.7*(1+0.04)/0.1-0.04=116.113
Now we need to discount 116.113 back one year so 116.113/1.1= 105.57
The present value of Stock B is 105.57
For stock C the next year dividend is 6.7 and then for 5 years the growth rate is 20% and then 0 forever so we need to find the value of stock C 6 years from now and then discount it back.
Dividend 1 year from now = 6.7
Dividend 6 years from now= 6.7* (1.2)^5=16.67
Value of stock 6 years from now
D= 16.67
G= 0
R= 10
16.67*(1+0)/(0.1-0)
=166.7174
Now we need to discount back this value 6 years to find the present value of the stock
166.7174/1.10^6
=94.10
The highest present value at a market capitalization of 10% for each stock is of stock A which is $134
Explanation:
