Question

The Red Bud Co. pays a constant dividend of $3.10 a share. The company announced today that it will continue to do this for another 2 years after which time they will discontinue paying dividends permanently. What is one share of this stock worth today if the required rate of return is 8.7 percent?

Answer 1

The stock is worth $5.48 today

Step-by-step explanation:

The dividend on this stock is just like an annuity as the amount of dividend is constant and they are paid after a constant interval of time and for a defined period of time. Thus, the price of this share today will be the present value of annuity or the present value of expected future dividends. Using the present value of ordinary annuity formula, the price of the stock will be,

Price today = 3.1 * [ (1 - (1+0.087)^-2) / 0.087 ]

Price today = $5.475 rounded off to $5.48