Question

A Corporation will pay a dividend of $1.75 per share at this year's end and a dividend of $2.25 per share at the end of next year. It is expected that the price of its stock will be $42 per share after two years. If the firm has an equity cost of capital of 9%, what is the maximum price that a prudent investor would be willing to pay for a share of the stock today

Answer 1

Answer:

$38.85

Explanation:

The computation of the maximum price would be willing to pay is shown below:

Current price = Future dividend × Present value of discount factor (rate of interest , time period)

= $1.75 ÷ 1.09 + $2.25 ÷ (1.09^2) + $42 ÷ (1.09^2)

= $1.61 + $1.89 + $35.35

= $38.85

Simply applied the above formula so that the maximum price could come