Assume the Gordon model is appropriate for valuing stocks A and B. Based on the
ID: 2729279 • Letter: A
Question
Assume the Gordon model is appropriate for valuing stocks A and B. Based on the following data, the two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist. True or False?
A B
price 25 25
Expected growth (constant 10% 5%
Required Return 15% 15%
Explanation / Answer
False
The Price of stock A by Gordon model=25=Exp. next year Dividend of A/(.15-.10)
=>Exp next year Dividend of A=25*(.05)=1.25
The Price of stock B by Gordon model=25=Exp. next year Dividend of B/(.15-.05)
=>Exp next year Dividend of B=25*(.10)=2.5
Therefore the expected dividend for A is 1.25 while the expected Dividend for B is 2.5 therefore its possible for the two stock to have the same Price of 25 based on the different Dividends expectations for the stock A and B based on the Gordon model.Thus the prices are equal does not mean that disequilibrium exists.Thus False.