Bill, Jim and Shelly are all looking to buy the same stock that pays dividends. Bill plans on holding the stock for one year. Jim plans on holding the stock for three years. Shelly plans on holding the stock until she retires in 10 years. Which one of the following statements is correct?

1. Bill will be willing to pay the most for the stock because he will get his money back in one year when he sells.

2. Jim should be willing to pay three times as much for the stock as Bill because his expected holding period is three times as long as Bill's.

3. Shelly should be willing to pay the most for the stock because she will hold it the longest and hence she will get the most dividends.

4. All three should be willing to pay the same amount for the stock regardless of their holding period.

Question

Litzy

Business

18 October, 11:28

Bill, Jim and Shelly are all looking to buy the same stock that pays dividends. Bill plans on holding the stock for one year. Jim plans on holding the stock for three years. Shelly plans on holding the stock until she retires in 10 years. Which one of the following statements is correct?

1. Bill will be willing to pay the most for the stock because he will get his money back in one year when he sells.

2. Jim should be willing to pay three times as much for the stock as Bill because his expected holding period is three times as long as Bill's.

3. Shelly should be willing to pay the most for the stock because she will hold it the longest and hence she will get the most dividends.

4. All three should be willing to pay the same amount for the stock regardless of their holding period.

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Answers (1)

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Declan Romero · Answer 1

4. All three should be willing to pay the same amount for the stock regardless of their holding period.

Explanation:

Bill, Jim and Shelly should be willing to pay the same amount of money to purchase this dividend-paying stock. This is because, the price of the stock today depends on the expected future dividends which when discounted, results in the intrinsic value of the stock. This is based on dividend discount model (DDM) of stock valuation. Therefore, the value of the stock today does not depend on the holding period.