Question

1) You are indecisive about which stock to buy Microsoft, which is selling for $173 a share; or Apple, which is selling for $285 a share. Microsoft stock promises to pay annual dividends of $4.00, $5.00, and $5.50 over the next three years respectively, and you estimate it can be sold for $190 at the end of the third year. You expect Apple to pay a dividend of $5.50 the first year, $8.50, and $10.50 over the next two years, respectively. You also expect Apple’s stock to be trading at $330 in three years. Which stock would you buy if stocks from computer manufacturers typically yield 10%?

Answer 1

Answer:

I would buy the APPLE stock

Explanation:

Microsoft stock price = $173  

dividends earned = $4, $5 and $5.5

value after 3 years = $190

Apple stock price = $285

Dividends earned = $5.5, $8.5 and $10.5

value after 3 years = $330

Applying the dividend discount model

IVO = present value of dividend + present value of terminal price

for Microsoft

IVO = ( 4/1.1 + (5/(1.1/2)) + ( 5.5/(1.1/3)) + ( 190/(1.1/3))

      = $154.65  

for Apple

IVO = ( 5.5/1.1 + ( 8.5/( 1.1/2)) + (10.5/(1.1/3)) + ( 330/(1.1/3))

       = $267.8

Note: the IVO's are less than the current price of the stocks ( IVO = the intrinsic value of the shares ) but Microsoft shares are overpriced compared to apple

Answer 2

Answer:

If decided to purchase, Apple will yield better

Explanation:

we solve for the present value of the future cashflow discounted at 10%

we will then compare against the current market price and pick with the better NPV

Microsoft:

$\left[\begin{array}{ccc}#&Cashflow&Discounted\\1&4&3.64\\2&5&4.13\\3&195.5&146.88\\TOTAL&&154.65\\\end{array}\right]$

154.65 - 173 = -18.36

Apple:

$\left[\begin{array}{ccc}#& Cashflow& Discounted\\1&5.5&5\\2&8.5&7.02\\3&340.5&255.82\\&TOTAL&267.84\\\end{array}\right]$

267.84 - 285 = -17.16

Now, as both are negative we must decide if we accep to receive less than 10% in which case, we will purchase stock as their net present alue is higher than microsoft.