Martin's Yachts has paid annual dividends of $1.40, $1.75, and $2.00 a share over the past three years, respectively. The company now predicts that it will maintain a constant dividend since its
Business has leveled off and sales are expected to remain relatively constant. Given the lack of
Future growth, you will only buy this stock if you can earn at least a 15% rate of return. What is the
Maximum amount you are willing to pay to buy one share of this stock today?

Question

Quizplus · Accepted Answer

To calculate the maximum amount we are willing to pay to buy one share of this stock today, we need to use the dividend discount model:

P = D / (r - g)

Where:
P = price of the stock today
D = dividend paid
r = required rate of return
g = growth rate of the dividend

Since the company predicts that it will maintain a constant dividend, g = 0. Therefore:

P = D / r

We want to earn at least a 15% rate of return, so r = 0.15. The last dividend paid was $2.00, so:

P = $2.00 / 0.15 = $13.33

Therefore, the maximum amount we are willing to pay to buy one share of this stock today is $13.33, which is option B.

Martin's Yachts Has Paid Annual Dividends of $1