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?

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TomShelby TomShelby · Answer 1 · 2019-12-15T02:22:19+01:00

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

[tex]\frac{Dividend}{(1 + rate)^{time} } = PV[/tex]

*1

Div: 3.00

time: 1

rate: 0.12

[tex]\frac{3}{(1 + 0.12)^{1} } = PV[/tex]

PV 2.678571429

*2

Dividends 4.25

time 2.00

rate 0.12000

[tex]\frac{4.25}{(1 + 0.12)^{2} } = PV[/tex]

PV 3.3881

*3

Maturity 106.00

time 3.00

rate 0.12000

[tex]\frac{106}{(1 + 0.12)^{3} } = PV[/tex]

PV 75.4487