In: Finance
Solution:
The formula for calculating the value of common stock is
Value of common stock = Present value of dividends for years ‘1 to n ‘ + Present value of common stock at year ‘ n ‘
As per the information given in the question we have n = 2 years
Thus the value of common stock = [ D1 * ( 1 / ( 1 + r)1 ) ] + [ D2 * ( 1 / ( 1 + r)2 ) ] + [ P2 * ( 1 / ( 1 + r)2 ) ]
As per the information given in the question we have
D1 = $ 0.25 ; D2 = $ 0.25 ; P2 = $ 40.00 ; r = 10.00 % = 0.10 ;
Applying the available information in the formula we have the value of common stock as :
= [ $ 0.25 * ( 1 / 1.10 )1 ] + [ $ 0.25 * ( 1 / 1.10 )2 ] + [ $ 40.00 * ( 1 / 1.10 )2 ]
= [ $ 0.25 * 0.909091 ] + [ $ 0.25 * 0.826446 ] + [ $ 40.00 * 0.826446 ]
= $ 0.227273 + $ 0.206612 + $ 33.057851
= $ 33.491736
= $ 33.49 ( when rounded off to two decimal places )
Thus the value of Newco’s Common Stock at the end of the 2-year time period = $ 33.49