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Consider two stocks. For each, the expected dividend next year is $100, and the expected growth rate of dividends is 3 percent. The risk premium is 3 percent for stock x and 8 percent for stock y. The economy's safe interest rate is 5 percent.
a. Use the Gordon growth model to compute the price of each stock. Why is one price higher than the other? What does the difference in risk premiums tell us about the dividends from each stock? Please show all your steps and explain your answer to get full points.
b. Suppose the expected growth rate of dividends rises to 5 percent for both stocks. Compute the new price for each stock. Which stock's price changes by a larger percentage? Explain your answer. Please note, you need to show all your steps and explain your answer to get full marks
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