Question

Because of declining​ world-wide sales of its number one​ confection, the petit​ ourson, Bearsbum Confection announced today that it is suspending dividend payments on its preferred shares. The shares have a 5.7% annual​ dividend, have a par value of $107 and are cumulative. The next dividend would have been paid tomorrow​ (if it were not​ suspended). Analysts expect​ Bearsbum's profits to rebound strongly in the next year and half due to the introduction of a new line of sour gummy bear paws. As a​ result, analysts expect that Bearsbum will resume dividends of $6.10 in two years time. What is the fair price for the shares today if investors require a return of 7.2%​?

A.

$53.79

B.

$134.48

C.

$89.65

D.

$125.51

Answer 1

~ Arrears of dividend of Year 0, Year 1, Year 2 will be paid at the end of Year 2.

~ Therefore, $6.10 x 3 years = $18.30 will be paid at the end of year 2.

~ Terminal Value as on Year 2 End = $6.10 / 0.072 = $84.72

~ Fair Price of the Stock as on Today:

= (Arrears of Dividend + Terminal Value as on year 2) / (1 + r)²

= ($18.30 + $84.72) / 1.072²

= $89.65

Therefore, Answer = C. $89.65