Question

You want to invest in a stock that pays $5.00 annual cash dividends for the next four years. At the end of the four years, you will sell the stock for $20.00. If you want to earn 12% on this investment, what is a fair price for this stock if you buy it today?

Answer 1

Answer: $27.90

Explanation:

Discount the dividends and the price you will sell the stock at in 4 years at 12%.

The dividends are a constant and so can be treated as annuities.

= (5 * Present value factor of annuity, 4 years, 12%) + 20/(1 + 12%)⁴

= (5 * 3.0373) + 12.71036

= $27.90