Question

Wilbert's Clothing Stores just paid a $1.25 annual dividend. The company has a policy whereby the dividend increases by 2% annually. You would like to purchase 100 shares of stock in this firm but realize that you will not have the funds to do so for another three years. If you desire a 12% rate of return, how much should you expect to pay for 100 shares when you can afford to buy this stock? Ignore trading costs.
A. $1,040
B. $1,160
C. $1,353
D. $1,766
E. $1,810

Answer 1

Answer:

option (C) $1,353

Explanation:

Annual dividend paid = $1.25

Increase in dividend annually, g = 2%

Number of stocks to be purchased = 100

Rate of return, r = 12%

Price at the end of Year 3 = $\textup{Annual dividend}\times\frac{\textup{(1+g)}^n}{\textup{r-g}}$

here, n = 4 (after 3 years)

Price at the end of Year 3 = $\textup{1.25}\times\frac{\textup{(1+0.02)}^4}{\textup{0.12-0.02}}$

or

Price at the end of Year 3 = $\textup{1.25}\times\frac{\textup{1.0824}}{\textup{0.1}}$

or

Price at the end of Year 3 = $13.53

Therefore,

Expected amount to be paid for 100 shares = $13.53 × 100 = $1,353

Hence,

the correct answer is option (C) $1,353