Question

Slg, inc. announced today that they will be increasing their annual dividend to $1.60 per share next year. After that, they expect to increase the dividend by 3% annually. You want to buy shares of stock in this company but cannot afford to do so for another two years. At that time, you will buy shares if you can earn a 12% rate of return. How much will you be willing to pay for one share of this stock two years from today?

Answer 1

To calculate the price you would be willing to pay for one share of this stock two years from today, we need to determine the present value of the future dividends.

Step-by-step explanation:

To calculate the price you would be willing to pay for one share of this stock two years from today, we need to determine the present value of the future dividends.

First, let's calculate the present value of the dividend payment two years from now. Since the dividend is expected to increase by 3% annually, we can use the formula for the present value of a growing perpetuity: PV = D / (r - g), where PV is the present value, D is the dividend payment, r is the required rate of return, and g is the growth rate of the dividend. Plugging in the values, we get PV = $1.60 / (0.12 - 0.03) = $19.05.

Next, let's calculate the present value of the dividend payment one year from now. We apply the same formula: PV = D / (r - g), where D is the dividend payment one year from now and g is still 3%. Plugging in the values, we get PV = $1.60 / (0.12 - 0.03) = $19.05.

Lastly, we calculate the present value of the current dividend payment, which is $1.60 divided by (1 + r)², where r is the required rate of return. Plugging in the values, we get PV = $1.60 / (1 + 0.12)² = $1.29.

To determine the price you would be willing to pay for one share of this stock two years from today, we add up the present values of the dividend payments: $19.05 + $19.05 + $1.29 = $39.39.