ECON 310: Problem Set #3 Please submit through Canvas Due Date: October 23, 2020 For all of the questions in this problem set, assume there is no tax at all. Stocks Consider stock A with a dividend yield equal to 2.5% (based on its dividend payments over the past year) The dividends are expected to grow it 8% per year. Stock A is currently traded at $52 per share. 1. According to Gordon's model, what would be the expected return on the stock? Answer: The Gordon's model states that 1+ P =D TE-9 Rearrange the terms we get 18 = +9+9= 25$ (1 +5%) + 8% = 10.7% 2. Suppose the total dividends paid over the next year is $1.4 per share, leading to a downward revision of the expected dividend growth rate to 7.5%. Assume the expected rate of return remains the same for this stock, what would be the actual rate of return from holding this stock over the next year? Answer: The price of stock A a year from now, according to Gordon's model is 1+9 1 +7.5% P.1 D+1 TE- 10.7% -7.5% = $47.03/share The rate of return is Detit 1- R4,041 = P 1.4 + 47.03-52 52 =-6.8756 3. Consider stock B which just paid $6 in dividends over the past year. The expected return on the stock is 12.5% and the stock is currently traded at $120 per share. At what rate are the dividends expected to grow for this stock according to Gordon's model? Answer: Again, starting with the Gordon's model 1+9 P. - DITE-4 and rearrange the terms we have PTE- ) = D. (1+)