Question

Universal Air is a no-growth firm and has two million shares outstanding. It expects to earn a constant $20 million per year on its assets. If it has no debt, all earnings are paid out as dividends, and the cost of capital is 10 percent, calculate the current price per share of the stock.

a. $50
b. $150
c. $200
d. $100

Answer 1

To find the stock price for Universal Air, the dividend discount model is applied using the formula price equals dividends divided by cost of capital. Given the dividend distribution of $20 million among two million shares and a 10 percent cost of capital, the stock price is calculated at $100 per share.

Step-by-step explanation:

To calculate the current price per share of Universal Air's stock, we must determine the value of the dividends that will be distributed to shareholders. As Universal Air is a no-growth firm and plans to pay out all its earnings in dividends, we can simply use the dividend discount model for a no-growth firm, which is given by the formula Price = Dividend / Cost of Capital. With expected constant earnings of $20 million per year, two million shares outstanding, and a 10 percent cost of capital, we calculate the price per share as follows:

Dividends per share = $20 million / 2 million shares = $10 per share

So,

Price per share = Dividend per share / Cost of Capital = $10 / 0.10 = $100

The correct answer is d. $100.