Question

You are considering the purchase of a share of Ranch's common stock. You expect to sell it at the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the end of the year. Ranch just paid a dividend of $2.25. If your required return on this stock is 12%, what is the most you would be willing to pay for it now

Answer 1

Current dividend paid(Do) = $2.25

Dividend in 1 year's time(D1) = $2.50

Market price in 1 year's time(P1) = $32

Required return on common stock(Ke) = 12% = 0.12

Po = D1 + P1/ 1 + Ke

Po = $2.50 + $32/ 1 + 0.12

Po = $34.50/1.12

Po = $30.80

Step-by-step explanation:

The current market price of the stock is a function of dividend paid in 1 year's time and market price in 1 year's time capitalised at the required return on equity.