Final answer:
To determine the worth of Red Bud Co.'s stock, we use the present value of the dividend payments, assuming a 7.4% required rate of return. Calculating the present value of two $1.80 dividends to be received over the next two years, the stock is valued at $3.24 today.
Step-by-step explanation:
To determine the value of a share of stock for Red Bud Co. that pays constant dividends with a specified endpoint, one would use the dividend discount model for a finite period. According to the details provided, Red Bud Co. will be paying a dividend of $1.80 per share for the next two years, after which no further dividends will be paid. Given a required rate of return of 7.4%, we calculate the present value of the dividends.
To calculate the present value (PV) of the anticipated dividends, we use the formula:
PV of Dividends = Dividend / (1 + required rate of return)^n
Where:
The total PV of the dividends is the sum of the present values of each individual dividend payment.
For the first payment:
PV1 = $1.80 / (1 + 0.074)^1 = $1.68
For the second payment:
PV2 = $1.80 / (1 + 0.074)^2 = $1.56
Now, we sum these two amounts to find the total value of the stock:
Value of stock = PV1 + PV2= $1.68 + $1.56= $3.24
Therefore, option a, $3.24, is the current worth of one share of Red Bud Co.’s stock if they are paying constant dividends for two more years before ceasing dividend payments.