Question

One-period pricing. Recall that since stocks have really long lives, in the video we first imagined owning a stock for only one period. In this simple, yet powerful scenario, today's stock price is the PV of next year's dividend and next year's stock price). The stock of Alydar Oil, an all-equity firm, is currently trading at $30 per share, after just having paid a $2.40 per share dividend. The market expects a dividend of $3.10 per share to be paid one year from today. If the equity cost of capital (same as discount rate for equity) is 12% for this firm, the expected ex-dividend price (the stock price after the dividend is paid next year) in one year (t = 1) should be closest to:_____.
a. $31.20.
b. $31.05.
c. $30.50.
d. $33.60.

Answer 1

Answer:

c. $30.50

Explanation:

As rightly said, the current stock price is the present value of a dividend in one year and the expected price at the end of the year discounted at the equity cost of capital which is 12% in this case

current share price=D1+P1/(1+cost of equity)^n

current share price=$30

D1=$3.10(dividend expected in one year)

P1=unknown(price in one year)

cost of equity=12%

n=investmet time horizon=1 year

$30=$3.10+P1/(1+12%)^1

$30*(1+12%)=$3.10+P1

$33.60=$3.10+P1

P1=$33.60-$3.10

P1=$30.50