Fin630 Assignment No. 1 Solution

“Investment Analysis & Portfolio Management” (Fin 630)

Dividend Discount Model
Company A is currently selling for Rs. 90 and paying dividend of Rs. 10 per share. Dividend is expected to grow at rate of 5 percent per year. The required rate of return for investors is 17% to invest in the stock with the degree of riskiness.
Company B is currently selling for Rs. 85 and paying dividend of Rs. 10 per share. For the next year dividend is Rs. 10.6 per share, which shows growth rate of 6 percent per year. The required rate of return for investors is 17% to invest in the stock with the degree of riskiness.

A) Calculate the price of stock for Company A and Company B using Dividend Discount
Model.
Solution A:
Po for A = D(1+g)/r-g
Po = 10(1+0.05)/0.17 – 0.05
Po = 10(1.05)/0.12
Po = 10.5/0.12
Po = 87.5

Po for B = D(1+g)/r-g
Po = 10(1+0.06)/0.17 – 0.06
Po = 10(1.06)/0.11
Po = 10.6/0.11
Po = 96.36
B) If you have to choose one of these two stocks, which stock you will buy?
Solution B:

In part B I will buy the stock of company "B" because its current market price is low than fair price which we have calculated by using dividend discount model. Stock of company "B" also has greater growth rate than stock of Company "A"

C) If both companies have decided not to pay cash dividend but they are offering 10%
stock dividend. If you are holding 500 shares of Company A and 1,000 shares of
Company B, calculate total number of shares of each Company you will hold after
receiving stock dividend.

Solution C:

Company offers 10% stock dividend to all shareholders. Means that if you own 100 shares than company will give you 10 more shares free of cost. Number of shares increases but Total Value of Firm is unchanged.

Company A = 500 Share x 10%
Company A = 500 Share x 0.10
Company A = 50
Total Number of Shares = 500+50
Total Number of Share = 550 shares

Company B = 1000 Share x 10%
Company B = 1000 Share x 0.10
Company B = 100
Total Number of Shares = 1000+100
Total Number of Shares = 1100 shares