Question

Suppose that a friend has started a business selling software. The software is a great​ hit, and the firm quickly grows large enough to be able to sell stock. Your​ friend's firm promises to pay a dividend of ​$9 per share every year for the next 55 ​years, at which point your friend intends to shut down the business. The​ firm's stock is currently selling for ​$124 per share. If you believe that the company really will pay dividends as stated and if you require a rate of return of 8​% to make this​ investment, should you buy the​ stock?

Answer 1

Answer:

No, we should not buy the stock

Explanation:

The question states that after 55 years, the friend intends to close the company. That implies that after 55 years the value of the purchased share would be $0.

For next 55 years he has promised to pay $9 as a dividend each year.

The share selling price is $124 per share.

To decide whether to buy the share or not, we must first calculate the present value of the dividends to be paid, and then compare that value to the share's selling price and if the present value of the dividends received is greater than the share's sale price then the share will not be purchased.

Dividend per year = $9

Rate of return = 8%

Period = 55 years

Present Value = $9(P/A, 8%, 55)

Present Value =  $110.87

The present value of dividends to be received is $110.87

The present value of dividends to be received is less than the selling price of share.

So, we should not buy the stock.