Question

Nu yu announced today that it will begin paying annual dividends. The first dividend will be paid next year in the amount of $0.65 a share. The following dividends will be $0.70, $0.85, and $1.15 a share annually for the following three years, respectively. After that, dividends are projected to increase by 1.2 percent per year. How much are you willing to pay today to buy one share of this stock if your desired rate of return is 16 percent?

(a) $3.76
(b) $4.20
(c) $4.85
(d) $5.15

Answer 1

An investor would calculate the present value of the future dividends expected from Babble, Inc. based on their required rate of return.

Step-by-step explanation:

Given that there are 200 shares, and the company expects profits of $15 million, $20 million, and $25 million over the next three years respectively, the dividend per share would be $75,000 ($15 million/200), $100,000 ($20 million/200), and $125,000 ($25 million/200).

Assuming the investor wants a certain percent return, they would use this percentage to discount each year's dividend back to present values and then sum those values to find the total they would be willing to pay for a share today.

Without knowing the investor's required rate of return, we cannot give a precise number, but, in general, the price paid would need to reflect the time value of money such that the present value of the dividends equals the share price paid.