Question

Stocks F and I are valued using the dividend discount model. The required annual effective rate of return is 8.8% The dividend of Stock F has an annual growth rate of g and the dividend of Stock ) has an annual growth rate of -g. The dividends of both stocks are paid annually on the same date. The value of Stock Fis twice the value of Stock J. The next dividend on Stock Fis half of the next dividend on Stock Calculate g.

Answer 1

Stock F share price = Df/(k-g)

Stock J share price= Dj/(k+g)

where Df= Dividend of F ; Dj=dividend of J ; k=effective return =8.8% ; g=growth rate

Df/(k-g)=2* Dj/(k+g) ------ equation 1

Df=.5*Dj ----- equation 2

substituting equation 2 in equation 1

.5*Dj/(.088-g) =2*Dj/(.088+g)

4=(.088+g)/(.088-g)

.352-4g=.088+g

.264=5g

g=.0528 =5.28%