Question

Blockbuster Inc. just paid a dividend of​ $2 per share. Dividends are expected to grow at a rate of minus​ 50% annually over the next three years. After​ that, it is expected that Blockbuster will cease paying dividends forever. What is the fair market price for a share of Blockbuster if shareholders require a return of​ 12%?

A) $2.21
B) $2.95
C) $1.61
D) $0
E) $1.47

Answer 1

E) $1.47

Step-by-step explanation:

Hi, first we need to estimate the value of all future dividends, since last dividend was $2 and it´s going to grow at -50% every year, for 3 years and then stop paying dividends, the cash flows that we need to bring to present value are.

D(1)= $2*(1-0.5)=$1

D(2)=$1*(1-0.5)=$0.50

D(3)=$0.50*(1-0.5)=$0.25

And no dividends from then on.

Now, we need to bring them to present value in order to find the pair market price of this share, that is:

`Price=(1)/((1+0.12)^(1) ) +(0.50)/((1+0.12)^(2) ) +(0.25)/((1+0.12)^(3) )`

`Price=0.893+0.399+0.178=1.47`

So, the price of this share is $1.47, that is E)

Best of luck