Question

Owen inc. has a current stock price of $15.00 and is expected to pay a $0.80 dividend in one year. if owen's equity cost of capital is 12%, what price would its stock be expected to sell for immediately after it pays the dividend?

Answer 1

As it is known that future cash flows are risky in nature so it is not possible to discount them at risk free rate. So investor must discount the future cash flows based on the equity cost of capital. It is the expected return of the other investments available in the market with same kind of risk to the firm’s share.

Price of the stock can be found by using the cost of equity equation which is as follows:

Po = Div_1 + P_1 / 1 + r_E

$15 = 0.8 + X / 1.12

X = $16

So the expected selling price of the stock is $16.00