Consider the following three stocks: a. stock a is expected to provide a dividend of $10 per share forever. b. stock b is expected to pay a dividend of $5 next year. thereafter, dividend growth isexpected to be 4% per year forever. c. stock c is expected to pay a dividend of $5 next year. thereafter, dividend growth isexpected to be 20% per year for 5 years and zero thereafter. if the market capitalization rate for each stock is 10%, which stock is the most valuable?

Stock A is the best option.

Explanation:

We use gordon dividend model

return for all stock = 10%

Stock A

dividend 10

grow = 0

10/.1 = 100

Stock B

dividend 5

grow 0.04

5/(0.10-0.04) = 83.33

Stock C

For this case, we will calculate the present value of the dividends, as there is a finite number

We get each dividen by multiply the previous one by the grow rate

Year 1:      5dividends x (1 + 20% grow)= 5 x 1.2 = 6

Year 2:     6 dividends x 1.2 = 8.64

And so on.

Then we calcualte the present value for each dividend:

Then we add them together and get the value of stock C

stock C 32.7031

From the comparrison, Stock A is the best option.