Question

You own 2,750 common shares of a company, which will pay a dividend of $2.23 per share next year and a liquidating dividend of $64.60 per share in two years form today. The require return on the common shares is 9.22%. You want to create a homemade dividend so that you can get an equal dollar amount of total dividends in each of the two years. What will be the amount of homemade dividend in the second year? $81,504 $83,706 $85,909 $88,112 $90,315

Answer 1

Solution

Answer-88112

Here we have dividends being paid in 2 years

Present value of dividends paid in 2 years = Present value of dividend recieved in first year+PV of dividend recieved in second year

Dividend recieved first year=number of shares*dividend per share=2750*2.23=6132.500

Dividend recieved at end of second year=number of shares*dividend per share=64.6*2750=177650.00

formula for Present value is

Present value=Cashflow/(1+r)^n

where

r=Req rate of return of common stocks=9.22%

n=period in which cashflow occurs

Therefore Present value of dividends recieved in 2 years=6132.500/(1+.0922)^1+177650/(1+.0922)^2

=154537.502

The calculation for equal annual payments of homemade dividends is to be made

The present value of dividends recieved in 2 years should be equal to present value of annuity payments of the homemade dividends (2 payments)

present value of dividends paid in 2 years=Annual dividend payment of homemade dividend*((1-(1/(1+i)^m))/i)

where

i=rate of retun require=9.22%

m=number of periods=2

154537.502=Annual dividend payment*((1-(1/(1+.0922)^2))/.0922)

Solving we get Annual dividend payment (Home made dividend)=88112.00

Thus homemade dividend in second year=88112.00

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