Question

A stock is expected to pay its first $0.1 dividend in 3 years from now (t=3). The dividend is expected to be paid annually forever and grow by -2% pa (note the negative sign). The discount rate is 6% pa. Estimate what the stock price will be in 3.25 years from now. The stock price at time 3.25 is expected to be: Select one:

a. $1.1726
b. $1.243
c. $1.25
d. $1.2683
e. $1.3176

Answer 1

To calculate the stock price, we use the present discounted value (PDV) formula with the provided information of dividend, dividend growth rate, and discount rate. The stock price in 3.25 years is estimated to be $1.25.

Step-by-step explanation:

To calculate the stock price, we need to use the concept of present discounted value (PDV). Since the first dividend of $0.1 will be paid in 3 years and the dividend is expected to grow by -2% per year, we can calculate the present value of the dividend stream using the discount rate of 6% per year. The formula to calculate the present value is: Dividend / (discount rate - dividend growth rate).

Dividend in year 3 = $0.1

Dividend growth rate = -2%

Discount rate = 6%

Using this information, we can calculate the present value of the dividend in year 3:

Present Value = $0.1 / (0.06 - (-0.02)) = $0.1 / 0.08 = $1.25

Therefore, based on the present value of the dividend, the stock price in 3.25 years from now will be $1.25.