Mr. Ali is a potential investor of stocks (equity); he prefers to invest in equity securities rather than the debt securities. He collects information of different companies having share capital and will select two most appropriate companies as per his own knowledge. But he is confused while selecting the best company of the two.
Company A just paid the dividend of Rs. 24 per share to its shareholders (Dividend Growth Rate is 10%) and Company B just paid the dividend of Rs. 21 per share to its shareholders (Dividend Growth Rate is 12%). You are required to help Mr. Ali to decide which company is more appropriate for investment by answering the following questions:
a. Calculate the value of stocks of both companies by using Zero Growth Model if required Rate of Return is 15%. ( 5 Marks )
b. Calculate the value of stocks of both companies by using Constant Growth Model if required Rate of Return is 15% ( 5 Marks )
c. Calculate the Total return/yield; Dividend Gain Yield and Capital Gain Yield if stock price of Company A is Rs. 200 and Company B is Rs. 190 after 2 years. (Note: Take the current prices of stocks calculated in option a) ( 8 Marks )
Solution: dividend gain yield = dividend/ beginning price of stock
d. Based on the above results, suggest which company is more appropriate for investment? ( 2 Marks)
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