Question

Assume that you plan to buy a share of XYZ stock today and to hold it for 2 years. Your expectations are that you will not receive a dividend at the end of Year 1, but you will receive a dividend of $9.25 at the end of Year 2. In addition, you expect to sell the stock for $150 at the end of Year 2. If your expected rate of return is 16 percent, how much should you be willing to pay for this stock today?

Answer 1

Price to be paid today = $118.35

Step-by-step explanation:

The price of a share can be calculated using the dividend valuation model

According to this model the value of share is equal to the sum of the present values of its future cash dividends discounted at the required rate of return.

The model can applied as follows:

PV of dividend = D×(1+r) ^(-n)

D- dividend , r - required rate , n- number of year

D- 9.25, r - 16%, n = 2

PV of dividend = 9.25 × (1.16)^(-2)= 6.9

PV of disposal value

PV of dividend = F × (1+r) ^(-n)

D- disposal value , r - required rate , n- number of year

PV of disposal value = 150 × (1.16)^(-2)= 111.47

Price to be paid today

Total present value = 6.9 + 111.47 = 118.35

Price to be paid today = $118.35