Question

Diets For You announced today that it will begin paying annual dividends next year.

The first dividend will be $1.25 a share. The following dividends will be $0.25, $0.25,

$0.50, and $0.75 a share annually for the following 4 years, respectively. At the end of

the fifth year, the stock could be sold for $18. How much are you willing to pay to buy

one share of this stock today if your desired rate of return is 8.5 percent?

$14.39

Please Show all work and steps typed as I am on mobile

Answer 1

The current fair price of the stock should be equal to the total (summed) present value of the stock's expected dividends and future sale price discounted at the desired rate of return of 8.5 %

Therefore, fair price of stock = 1.25 / 1.085 + 0.25 / (1.085)^(2) + 0.25 / (1.085)^(3) + 0.5 / (1.085)^(4) + 0.75 / (1.085)^(5) + 18 / (1.085)^(5) ~ $ 14.39