Red Royal Industrial stock pays quarterly dividends and has an expected annual return of 15.88 percent....

Red Royal Industrial stock pays quarterly dividends and has an expected annual return of 15.88 percent. The stock is expected to have a price of 111.23 dollars in 3 months from today and is expected to have a price of 111.43 dollars in 6 months from today. What is the current price of Red Royal Industrial stock if the firm is expected to pay quarterly dividends forever and the quarterly dividend in 3 months from today is expected to be 3.96 dollars?

Expert Solution

Price of dividend formula is		P0 = (P1+D1)/(1+ke)

To find Current price, P1 is known, but quarerly dividend is not known, But price of stock in 3 months and in 6 months is given. So first we will calculate dividend from above formula. P1 is known, P2 is known and D2 will be find out. D2 means quarterly dividend is same in given year.
Annual Expected rate of return			15.88	%
Quarterly exp. Rate of return (15.88/4)=			3.97	% or	0.0397
Expected price in 3 months =			111.23
Expected price in 6 months =			111.43

P1 = ( D2 + P2 )/ (1 + Ke)
111.23 + (D1+111.43)/(1+0.0397)
111.23 * 1.0397 = D1 + 111.43
D2 =	4.215831

Quarterly dividned =	4.215831

So, Po = (P1+D1)/(1+ke)
P0 = (111.23 + 4.215831)/(1+0.0397)
P0 =	$ 111.04

So, Current price of stock is $111.04.

(b)
Quarterly dividend =			3.96	forever
Expected rate of return quarerly =			0.0397

Price of stock paying perpetual dividend = Dividend / ke
3.96 / 0.0397
$ 99.75

So, price of stock is $99.75.

jeff jeffy answered 1 year ago

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