Consider the following two stocks:
A: Stock A is expected to provide a dividend of $16 a share forever.
B: Stock B is expected to pay a dividend of $8 next year. Thereafter, dividend growth is expected to be 15% a year for seven years (i.e., until year 8) and 0% thereafter.
a) What are the prices of each stock if the appropriate discount rate for each stock is 14%? Which stock is the most valuable?
b) What are the prices of each stock if the appropriate discount rates are as follows: for the first eight years, the rate is 7%, and then 14% thereafter? Which stock is the most valuable?