You Are Considering the Shares of Two Firms to Add

question 75

Essay

You are considering the shares 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 shares of Firm A is 14%.Ignore taxes or transaction fees.
a.How much would investors pay for the shares of Firm A?
b.How much would investors pay for the shares 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:

Structuralism

An approach in psychology and other social sciences that emphasizes understanding the structure of the human mind or society by analyzing its components and their interactions.

Basic Elements

Fundamental components or parts that serve as building blocks for constructing or understanding a complex whole.

Gestalt Theory

The idea that the whole of personal experience is different from simply the sum of its parts.

Whole

Considered as an entire unit or entity, often in contrast to analyzing the separate components or parts.