Question

You are planning to purchase the stock of Ted's Sheds Inc. and you expect it to pay a dividend of $3 in year 1, $4.25 in year 2 and $6.00 in year 3. You expect to sell the stock for $100 in year 3. If your required return for purchasing the stock is 12%, how much would you pay for the stock today?

Answer 1

Answer:

I would pay up to 81.52 dollars for the share that way I will get a 12% return at least

Explanation:

We need to calcualte the present value of the cash flow of each year using the formula for present value of a lump sum:

      Dividends  Present Value

1st year     3.00 2.678571429 *1

2nd year     4.25 3.38807398  *2

3rd year 106.00* 75.44870627 *3

Value of the share  at 12% discount rate 81.51535168

*100 dollars from the sale plus 6 dollars of dividends

$\frac{Dividend}{(1 + rate)^{time} } = PV$  

*1

Div: 3.00

time: 1

rate: 0.12

$\frac{3}{(1 + 0.12)^{1} } = PV$  

PV  2.678571429

*2

Dividends 4.25

time  2.00

rate  0.12000

$\frac{4.25}{(1 + 0.12)^{2} } = PV$  

PV   3.3881

*3

Maturity  106.00

time  3.00

rate  0.12000

$\frac{106}{(1 + 0.12)^{3} } = PV$  

PV   75.4487