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

Answer:

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

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.