The Preferred Stock of ACE Pays a Constant $1

question 26

Essay

The preferred stock of ACE pays a constant $1.00 per share dividend. The common stock of ACME just paid a $1.00 dividend per share, but its dividend is expected to grow at 4% per year forever. ABLE common stock also just paid a dividend of $1.00 per share but its dividend is expected to grow at 10% per year for 5 years and then grow at 4% per year forever. All three stocks have a 12% required return. How much should you be willing to pay for a share of each stock? Which stock will give you the best return? Explain.

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Definitions:

Knew-It-All-Along Effect

A cognitive bias where people believe, after an event has occurred, that they predicted or knew the outcome beforehand.

Irrational Treatment

Behavior or actions that lack reason or logical thought, often leading to unfair treatment.

Sunk Costs

Expenses that have already been incurred and cannot be recovered, which should not affect future decision-making but often do.

Faulty Hindsight

The misjudgment of the reasons behind past decisions based on the outcome rather than on the information available at the time.