Suppose that a company’s dividends are expected to grow at a constant rate gd forever, and the price of the stock of the company is expected to grow at a constant rate of gp forever. The interest rate is constant, denoted by R. Compute the dividend next period if gd = 0.01, i.e., 10%.
(a) Suppose the next period’s dividend is $10, gd = 0.02, gp = 0, and R = 0.04.
(b) What goes wrong if we assume that the growth rate of the stock price exceeds the interest rate, i.e., gp > R? (c) (7 points) Using your answer to part (b), carefully explain why stock-market bubbles cannot last forever.