Question

Uncle John's Pipe Company has been experiencing several years of financial difficulty and, thus, has considered maintaining its dividend payment at $2.50 indefinitely. What is the value of its common stock if the required rate of return is 8.5 percent?

Answer 1

Answer: Value of the common stock = $29.41

Step-by-step explanation:

GIVEN the following ;

Dividend =$2.50

Rate of return (r) = 8.5% 0.085

The question above requires us to calculate the value of common stock which is equivalent to the present value of perpetuity which is the amount of a fixed income or cash flow an individual earns at regular interval for an INDEFINITE period.

RECALL;

PRESENT VALUE of PERPETUITY IS GIVEN BY:

PV of perpetuity = (Dividend or coupon per period ÷ interest rate(r))

PV of perpetuity = ($2.50 ÷ 0.085)

PV of perpetuity = $29.411

PV of perpetuity = $29.41

Answer 2

The value of its common stock is $29.41

Step-by-step explanation:

As the Dividend payment is for indefinite period of time, This is the perpetuity payment. The value of share can be determined by calculating the present value of perpetuity payment.

The formula for the present value of perpetuity is as follow

Present value of perpetuity = Cash flow / Required Rate of return

In this case the present value of perpetuity is the value of stock cash flows is The dividend payment.

Value of Stock = Dividend / Required Rate of return

Value of Stock = $2.5 / 8.5%

Value of Stock = $29.41