Question

Suppose Acap Corporation will pay a dividend of $2.79 per share at the end of this year and $3.05 per share next year. You expect Access stock price to be $50.94 in two years. Assume that Access equity cost of capital is 8.1%.

a. What price would you be willing to pay for a share of Acap stock today, if you planned to hold the stock for two years?
b. Suppose instead you plan to hold the stock for one year. For what price would you expect to be able to sell a share of Acap stock in one year?
c. Given your answer in (b), what price would you be willing to pay for a share of Acap stock today if you planned to hold the stock for one year?

Answer 1

To determine the price an investor would be willing to pay for a share of Acap stock today, we need to calculate the present value of the future dividends and the future stock price by discounting them using the equity cost of capital.

Step-by-step explanation:

To determine the price an investor would be willing to pay for a share of Acap stock today, we need to calculate the present value of the future dividends and the future stock price by discounting them using the equity cost of capital. The present value of the dividends is calculated as follows:

1. Year 1: $2.79 / (1 + 0.081) = $2.57
2. Year 2: $3.05 / [(1 + 0.081) * (1 + 0.081)] = $2.65

Next, we calculate the present value of the future stock price in year 2:

Present value = $50.94 / [(1 + 0.081) * (1 + 0.081)] = $44.01

Finally, we sum up the present values of the dividends and the stock price:

Total present value = $2.57 + $2.65 + $44.01 = $49.23

Hence, an investor would be willing to pay $49.23 for a share of Acap stock today if they planned to hold the stock for two years.

If the investor planned to hold the stock for one year, they would expect to be able to sell it at the end of the year for the future stock price in year 1. The present value of this future stock price is:

Present value = $50.94 / (1 + 0.081) = $47.13

Therefore, if the investor planned to hold the stock for one year, they would be willing to pay $47.13 for a share of Acap stock today.