Question

You are buying a share of UTD stock today. UTD is expected pay a dividend of $1.50 per share at the end of the year 2 and a $2.50 per share at the end of the year 3. You expect UTD 's stock price to be $20.00 at the end of year 3 (right after the $2.50 dividend is paid). UTD 's equity cost of capital is 10%.

a. What is the price of UTD stock per share today?

b. What will be the price one would expect to be able to sell UTD stock for at the end of year 2 (right after the dividend of $1.50 is paid)?

c. Suppose you plan on purchasing UTD stock at the end of year 2, right after the $1.50 dividend is paid. You then plan on selling your stock at the end of year 3, right after the $2.50 dividend is paid. What is your return from holding UTD stock?

Answer 1

Answer :

Given,

Expected dividend at year end 2 - $1.50

Expected dividend at year end 3 - $2.50

Expected stock price at year end 3 - $20

r (Rite of equity) - 10%

(a). Price of UTD"S share today is the present value of the return which he recceived in the form of dividend and price of shares

P0 = Dn/(1+r)n+Pn/(1+r)n

= $1.50/(1.10)2 + $2.50/(1.10)3 + $20/(1.10)3

= $18.144 per share.

(b). Expected price at which one would expect to sell the share at the end of the year 2 is the present value at the end of year 2 of the return which he received in the form of dividend and price of shares

Expected price of UTD's share at the end of year 2 i..e P2 = D3/(1+r) + P3/(1+r)

= $2.50/(1.10) + $20/(1.10)

= 20.4545

(c). If an investor purchase UTD's share at the end of year end 2 and should out the same at the end of year 3 after receipt of dividend then return from holding of share is

Price paid at the year end 2 against purchase of stock $20.4545 as per point b above

Less : Amount received on sell of shares $20

Therefore return from holding of shares is ($0.4545)as per share.

Return in % term is - ($20-20.4545*100

= (2.22)%