Question

In: Finance

The dividend on a company's stock will be $3.25 in one year, $4.25 in two years...

The dividend on a company's stock will be $3.25 in one year, $4.25 in two years and $5.25 in three years. In three years, you can sell the stock for $42.50. If you require a 9.75% rate of return on your investment, how much are you willing to pay for a share of this stock?

$20.64

$21.20

$21.75

$22.31

$22.87

Solutions

Expert Solution

Dividend in yr 1(D1) = $3.25

Dividend in yr 2(D2) = $4.25

Dividend in yr 3(D3) = $5.25

Price in yr 3(P3) = $42.50

Required rate of return(r) = 9.75%

Current price(P0) = ?

We can calculate the current price by using the Dividend discount model(DDM).

DDM is a method used to predict the current price of a share based on the theory that the value today will be equal to the sum of the present value of all dividends payments to be received in the future.

The formula is,

P0 =

=

= 2.96 + 3.52 + 36.12

= $42.60

The fair value of the stock should be $42.60

This answer isn't given in the options. Either the question is wrong or the options are wrong. The answer will be $42.60 according to the values provided. Please verify and let me know in the comments. I will be happy to solve it again if there is an error. Thanks.

jeff jeffy answered 1 year ago
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