Consider two stocks. For each, the expected dividend next year is $100 and the expected growth rate of dividends is 3%. The risk premium is 3% for one stock and 8% for the other. The economy's safe interest rate is 5%.
a. What does the difference in risk premiums tell us about the dividends from each stock?
b. Use the Gordon growth model to compute the price of each stock. Why is one price higher than the other?
c. Suppose the expected growth rate of dividends rises to 5% for both stocks. Compute the new price of each. Which stock's price changes by a larger percentage? Explain your result.