You Are Considering the Stock of Two Firms to Add

question 105

Essay

You are considering the stock of two firms to add to your portfolio. The companies differ only with respect to their dividend policies. For both firms, investors expect EPS for each of the next two years to be $7 and dividends and ending price for each of the next two periods to be:
D1 D2 P2
Firm A $2 $2 $60.70
Firm B 4 4 56.42
The required rate of return for the stock of Firm A is 14%. Ignore taxes or transaction fees.
a. How much would investors pay for the stock of Firm A?
b. How much would investors pay for the stock of Firm B?
c. For a less-than-perfect world, provide an argument for each of the following:
(1) Investors prefer the dividend policy of Firm A.
(2) Investors prefer the dividend policy of Firm B.
(3) Firms prefer the dividend policy of Firm A.

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Definitions:

Logical Operations

The mental processes involved in reasoning and understanding complex concepts through logical thought.

Reasoning

The process of thinking about something in a logical way to form a conclusion or judgment.

Egocentric Thought

a cognitive perspective where an individual perceives the world solely from their own point of view, often seen in early childhood development.

Conservation

In psychological terms, it refers to a child's ability to recognize that the quantity of a substance remains the same despite changes in its shape or container.