Question

Suppose you are thinking of purchasing the stock of Moore Oil, Inc. You expect it to pay a $2 dividend in one year, $2.10 in two years, $2.15 in three years, and you believe that you can sell the stock for $15 at the end of year three. If you require a return of 15% on investments of this risk, what is the maximum you would be willing to pay?

a. $14.6
b. $13.19
c. $13.33
d. $12.15

Answer 1

The maximum price you would be willing to pay is $13.33 (Option C).

Step-by-step explanation:

The maximum price that you are willing to pay is equal to the sum of the present value of the returns (dividends plus selling price), at a discount rate of 15%.

We can calculate the present value as:

`PV=\sum CF_k/(1+r)^k\\\\PV=(2)/((1+0.15))+(2.1)/((1+0.15)^2)  +(2.15)/((1+0.15)^3)+ (15)/((1+0.15)^4)\\\\PV=1.74+1.59+1.41+8.58=13.32`

The maximum price you would be willing to pay is $13.33 (Option C).