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Consider a stock issued by Corporation A. The corporation is committed to pay to the stock a dividend each year. The dividend in the first year is $10. Then, dividends will grow at constant rate equal to 5%. Consider now a stock issued by Corporation B. Assume that today the stock from Corporation B has the same price as the one issued by Corporation A. Corporation B is committed to pay no dividends for the next 10 years. A constant dividend will then be paid each year (starting in year 11) forever. Assume that the annual interest rate is equal to 10% for both corporations.

  1. (a) What is the constant dividend amount promised by Corporation B starting in year 11?

  2. (b) Suppose that you hold stock A for one year. What is holding period return? What about stock B?

  3. (c) Compute annual capital gains for both stocks for the coming 20 years. Briefly comment on the differences between the two stocks.


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