Question

You are considering acquiring a common share of Powerquest Corporation that you would like to hold for one year. You expect to receive both $1.25 in dividends and $35 from the sale of the share at the end of the year. The maximum price you would pay for a share today is __________ if you wanted to earn a 12% return. a. $31.25 b. $32.37 c. $38.47 d. $41.32

Answer 1

Dividend at the end of the year (D1) = $1.25

Market price at the end of the year (P1) = $35

Required return on equity (Ke) = 12%

Current market price (Po) = ?

Po = D1 + P1

1 + Ke

Po = $1.25 + $35

1 + 0.12

Po = $36.25

1.12

Po = $32.37

The correct answer is B

Step-by-step explanation:

The current market price of the share equals dividend at the end of the year plus market price at the end of the year divided by 1 + required return.