Question

Estes Park Corp. pays a constant $6.95 dividend on its stock. The company will maintain this dividend for the next 12 years and will then cease paying dividends forever. If the required return on this stock is 10 percent, what is the current share price?

Answer 1

The present value of an annuity of n periodic payments of P at r% where payment is made annually is given by:

$PV=P \left[\frac{1-(1+r)^{-n}}{r} \right]$

Given that Estes Park Corp. pays a constant dividend of P = $6.95 on its stock. The company will maintain this dividend for the next n = 12 years and will then cease paying dividends forever. If the required return on this stock is r = 10 % = 0.1.

Thus, the current share price is given by:

$Current \ share \ price=6.95 \left[\frac{1-(1+0.1)^{-12}}{0.1} \right] \\ \\ =6.95\left[\frac{1-(1.1)^{-12}}{0.1} \right] =6.95\left(\frac{1-0.3186}{0.1} \right)=6.95\left(\frac{0.6814}{0.1} \right) \\ \\ =6.95(6.813)=\bold{\ 47.36}$

Therefore, the current share price is $47.36