Question

Valorous Corporation will pay a dividend of $ 1.90 per share at this​ year's end and a dividend of $ 2.35 per share at the end of next year. It is expected that the price of​ Valorous' stock will be $ 41 per share after two years. If Valorous has an equity cost of capital of 8​%, what is the maximum price that a prudent investor would be willing to pay for a share of Valorous stock​ today?

Answer 1

The multiple choices are as follows:

a) 41.45

b) 42.40

c) 38.92

d) 40.22

The correct option is C,$38.92

Step-by-step explanation:

The maximum price a prudent and rational investor would be willing to pay for a share of Valorous stock today is the present value of future cash flows promised by the stock.

The stock promised to pay dividend of $1.90 at year end ,$2.35 next year and would command a price of $41 per share at the end of next year.

Share price=$1.90/(1+8%)+$2.35/(1+8%)^2+$41/(1+8%)^2=$38.92

The above calculation makes of use of discounting factor which is given by 1/(1+r)^n

r is the cost of capital of 8%

n is the relevant of cash flow