Question

Suppose ACAP Corporation will pay a dividend of $2.84 per share at the end of this year and $1.01 per share next year. You expect ACAP's stock price to be $50.68 in two years. The equity cost of capital is 8.3%.

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. What price would you expect to be able to sell a share of ACAP stock for in one year?
c. Given your answer in part (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? How does this compare to your answer in part (a)?

Answer 1

To calculate the price you would be willing to pay for a share of ACAP stock today, you need to find the present value of the dividends and the future stock price. If you plan to hold the stock for two years, the price would be $47.03. If you plan to hold the stock for one year, the price would also be $47.03.

Step-by-step explanation:

To calculate the price you would be willing to pay for a share of ACAP stock today if you planned to hold it for two years, you need to find the present value of the dividends and the future stock price.

1. Calculate the present value of the dividends using the equity cost of capital as the discount rate. In this case, the dividends in year 1 are $1.01, and in year 2 they are $2.84.
2. Calculate the present value of the future stock price. To do this, use the equity cost of capital as the discount rate and the future stock price of $50.68 in two years.
3. Add up the present value of the dividends and the present value of the future stock price to get the price you would be willing to pay for a share of ACAP stock today.

If you planned to hold the stock for one year, you would expect to be able to sell it for the same price as the future stock price in one year, which is $50.68. So, the price you would be willing to pay for a share of ACAP stock today if you planned to hold it for one year would be $50.68.

The price you would be willing to pay for a share of ACAP stock today to hold it for one year is the same as the price to hold it for two years, which is $47.03. This is because the only difference in the calculation is the future stock price, and in both cases, the future stock price is $50.68.