Question

You own 1,100 shares of stock in Avondale Corporation. You will receive a $2.00 per share dividend in one year. In two years, the company will pay a liquidating dividend of $48 per share. The required return on the company's stock is 20 percent. a. Ignoring taxes, what is the current share price of your stock? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. If you would rather have equal dividends in each of the next two years, how many shares would you sell in one year? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) c. What would your cash flow be for each year for the next two years? Hint: Dividends will be in the form of an annuity.

Answer 1

Solution:

a. The current share price of stock, is the present value of dividend and liquidated dividend which is computed as follows.

= 1.67 + 33.33

= $35.00

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b. Now, we calculate the dividends, by using the present value of dividend

35.00 =

35 =

= $21.04

You want = $21.04 (1,100) = $23,144 in one year and will receive only $2.00 (1,100) = $2,200

The price after one year, is

= $40

In one year, you will sell:

($23,144 – 2,200) / $40 = 523.6 shares

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c. The cash flow is calculated as follows:-

Cash flow at time 1:

$2,200 + $40(523.6) = $23,144

Cash flow at time 2:

$48(1,100 – 523.6) = $27,667.20