12 a State whether True or false Explain The value of share

12. a). State whether True or false? Explain The value of share equals the discounted stream of future earnings per share. b). Consider the following two stocks: a. Stock A is expected to provide a dividend of $10 a share forever. b. Stock B is expected to pay a dividend of $5 next year. Thereafter, dividend growth is expected to be 4% a year forever. If the market capitalization rate for each stock is 10%, which stock is the most valuable? What if the capitalization rate is7%?

Solution

a ) True

The value of share equals the discounted stream of future earnings per share

b ) Stock A Stock B

Dividend $ 10 $ 5

Value of Share = Market price per Share = Dividend in next Year / (Capitalisation Rate - Growing rate)

When Capitalisation Rate is 10 %

Stock A

= 10 / 0.1

= $ 100

  Stock B

= 5 / 0.1-0.04

= 5/ 0.06

= $ 83.33

Hence , Stock A is more Valuable

When Capitalisation Rate is 7 %

Stock A

= 10 / 0.07

= $ 143

Stock B

= 5 / 0.07-0.04

= 5 / 0.03

= $ 167

Hence , Stock B is more Valuable