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 $75 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.)(Show work)
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.)(Show work)
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. (Do not round intermediate calculations.)(Show work)

Answer 1

a). P0 = PV of the dividends

= [$2 / 1.20] + [$75 / 1.20²] = $1.68 + $52.08 = $53.75

b). To find the equal two-year dividends with the same present value as the price of the stock, we set up the following equation and solve for the dividend (Note: The dividend is a two-year annuity, so we could solve with the annuity factor as well):

$53.75 = D/1.20 + D/1.20²

$53.75 = [1.20D + D]/1.20²

$77.40 = 2.20D

D = $77.40 / 2.20 = $35.18

We now know the cash flow per share we want each of the next two years. We can find the price of stock in one year, which will be:

P1 = $75/1.20 = $62.50

Since you own 1,100 shares, in one year you want:

Cash flow in Year 1 = 1,100($35.18) = $38,700

But you’ll only get:

Dividends received in one year = 1,100($2) = $2,200

Thus, in one year you will need to sell additional shares in order to increase your cash flow. The number of shares to sell in year one is:

Shares to sell at time one = ($38,700 - $2,200)/$62.50 = 584 shares

c). At Year 2, you cash flow will be the dividend payment times the number of shares you still own, so the Year 2 cash flow is:

Year 2 CF = $75[1,100 - 584] = $75 x 516 = $38,700