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.
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(a) What is the constant dividend amount promised by Corporation B starting in year 11?
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(b) Suppose that you hold stock A for one year. What is holding period return? What about stock B?
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(c) Compute annual capital gains for both stocks for the coming 20 years. Briefly comment on the differences between the two stocks.
