Question

Fred Tibbits has made a detailed study of the denim clothing industry. He's particularly interested in a company called Denhart Fashions that makes stylish denim apparel for children and teenagers. Fred has done a forecast of Denhart's earnings and looked at its dividend payment record. He's come to the conclusion that the firm will pay a dividend of $5.50 for the next two years followed by a year of $6.50. Fred's investment plan is to buy Denhart now, hold it for three years, and then sell. He thinks the price will be about $77.00 when he sells. What is the most Fred should be willing to pay for a share of Denhart if he can earn 15% on investments of similar risk? Round PVF values in intermediate calculations to four decimal places. Round the answer to two decimal places. Do not round intermediate calculations.

Answer 1

The price is computed as follows:

= Dividend in year 1 / (1 + rate of return)¹ + Dividend in year 2 / (1 + rate of return)² + Dividend in year 3 / (1 + rate of return)³ + Selling price in year 3 / (1 + rate of return)³

= $ 5.50 / 1.15 + $ 5.50 / 1.15² + $ 6.50 / 1.15³ + $ 77 / 1.15³

= $ 5.50 x 0.8696 + $ 5.50 x 0.7561 + $ 6.50 x 0.6575 + $ 77 x 0.6575

= $ 4.7828 + $ 4.15855 + $ 4.27375 + $ 50.6275

= $ 63.84