Final answer:
To calculate the maximum price you should pay for the stock, you discount the expected future cash flows (dividend and sale price) to the present value using the required rate of return. At a required return of 9.8%, the maximum price to pay for ABC Corp stock today is $44.93.
Step-by-step explanation:
To find this maximum price, you need to calculate the present value of the expected cash flows from the investment, which includes the dividend and the expected sale price of the stock, discounted at the required rate of return. Given the expected $2.33 dividend and a sale price of $47 at the end of one year, and a required return of 9.8%, we can use the following formula:
P = с (1 + r)^-t + Pn (1 + r)^-t
Where:
- P is the present value of the stock price
- c is the expected cash flow (dividend)
- r is the required rate of return
- t is the time period in years
- Pn is the expected sale price at the end of period t
Plugging in the values:
P = 2.33/(1 + 0.098)^1 + 47/(1 + 0.098)^1
After calculating:
Present value of the dividend: 2.33/1.098 = $2.12
Present value of the sale price: 47/1.098 = $42.81
The maximum price you should pay today for the stock, therefore, is:
P = $2.12 + $42.81 = $44.93
Planning your investment strategy and expecting a 9.8% return, the maximum price you should pay for ABC Corp stock today is $44.93.