Question

Agnes wants to purchase common stock of New Frontier Inc. and hold it for 8 years. The directors of the company just announced that they expect to pay an annual cash dividend of GHȼ8.00 per share for the next 10 years. Agnes believes that she will be able to sell the stock for GHȼ80 at the end of 8 years. In order to earn 12% on this investment, how much should Agnes pay for this stock?

Answer 1

Agnes should pay GHȼ81.47 for this stock.

Step-by-step explanation:

To calculate the price that Agnes should pay for the stock, we can use the formula for the present value of a stock. The present value of the future cash flows, which include the dividends and the sale price, is determined by discounting each cash flow by the required rate of return. In this case, the required rate of return is 12%. So, we can calculate the present value of the dividends and the sale price as follows:

Dividends: GHȼ8.00 * (1 - (1 + 0.12)^(-10)) / 0.12 = GHȼ49.67

Sale price: GHȼ80 / (1 + 0.12)^8 = GHȼ31.80

Finally, we can calculate the price that Agnes should pay for the stock:

Price = Present value of dividends + Present value of sale price

Price = GHȼ49.67 + GHȼ31.80 = GHȼ81.47