You are considering two investments.

- The first investment that you are analyzing is a preferred stock that sells for $1120 and pays an annual dividend of $150. Your required rate of return for this stock is 15 percent.

- The second investment is a common stock that paid last year a $45 dividend. The firms earnings per share have increased from $40 to $80 in 10 years to have an annual growth rate equal to 7% which also reflects the expected growth in dividends per share indefinitely. The stock is selling for $1050 and you think an appropriate required rate of return for the stock is 15 percent.

a. Estimate the value of the preferred stock and common stock using Dividend Discount Model. [4 marks]

b. Which investment(s) would you recommend? Explain your answer. [3 marks]

c. Explain the relationship between the price of a stock today and its growth rate, assuming a constant growth model. [1 mark]

d. Due to COVID-19, you expect the annual growth rate to decrease to 3% in the first year, before growing indefinitely at 5%. Evaluate the impact on the common stock. Clearly show your workings. [2 marks]