GROWTH, Inc.s next year earning is expected to be $6 per share. The company pays out 2/3 of its earning as dividend. Both dividends and earnings are expected to grow by 10% a year for the first 5 years, and grow by 4% a year indefinitely thereafter. STABLE, Inc. is like GROWTH in all respects except that its growth will stop after year 5. In year 6 and afterward, it will pay out all earnings as dividends. The discount rate for both companies is 8%.

(a) What are the values for each company?

(b) What are the P/E ratios for each company?

(c) Now, suppose the stock prices computed in (a) are the actual price. However, if you have assumed

that both companies earnings will grow by 4% a year (starting from year 1) indefinitely in computing the fair values, which stock should you buy?