Question

You want to invest in a stock that pays​ $2.00 annual cash dividends for the next four years. At the end of the four​ years, you will sell the stock for​ $27.00. If you want to earn​ 11% on this​ investment, what is a fair price for this stock if you buy it​ today?

Answer 1

Po = D1 + D2 + D3 + D4 + P4

(1 +K) (1 +K)2 (1 + k)3 (1 + K)4

Po = $2.00 + $2.00 + $2.00 + $2.00 + $27.00

(1 + 0.11) (1 + 0.11)2 (1 + 0.11)3 (1 + 0.11)4

Po = $2.00 + $2.00 + $2.00 + $29.00

(1.11) (1.11)2 (1.11)3 (1 .11)4

Po = $1.80 + $1.62 + $1.46 + $19.10

Po = $23.98

Step-by-step explanation:

The current market price of the stock is a function of dividend in year 1 divided by 1 + r plus the dividend in year 2 divided by 1 + r raised to power 2 plus dividend in year 3 divided by 1 + r raised to power 3 plus the aggregate of dividend and market price in year 4 divided by 1 + r raised to power 4. r denotes required return on stock.