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Unformatted text preview: MIT Sloan School of Management J. Wang 15.407 E52-456 Fall 2003 Problem Set 3: Common Stock Solution 1. (a) Yes. Dividend can only be constant or grow at constant rate. (b) Yes in the sense that you can only use the general formula if grow is indefinite. But you can extend the model easily to accommodate multi-stage growth. (c) Yes, otherwise the model will not give you a finite, positive number, which is definitely wrong. 2. (a) If the dividends grow at a faster rate than the required rate of return. That should not concern you in reality because you should always demand at rate of return that is higher than the expected growth rate. The other possibility is that lim T- > inf E [ P T ] (1+ r ) t goes to infinity. This is the no bubble condition. That should also not happen, because when you discount an infinite number of dividend payments, you have to hold on to the stock forever, and there is no reason why you can get an infinite payoff selling something you will never sell!...
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This note was uploaded on 01/19/2011 for the course 15 15.407 taught by Professor Wang during the Fall '03 term at MIT.
- Fall '03