Ricardo owns 642 shares of Sonic Automotive stock. The company recently issued a statement that it will pay a $1.25 per share dividend this year and a $1.50 per share dividend next year. Ricardo does not need the cash from the dividend this year but does need as much cash as possible next year. He earns an average of 7 percent on his savings so that is the required return he established for this stock. Ignoring taxes, what will Ricardo's homemade dividend per share be next year?

Question

Quizplus · Accepted Answer

Ricardo can reinvest this year's dividend of $1.25 per share at his average savings rate of 7%. To find the future value of this year's dividend next year, we use the formula for future value: FV = PV(1 + r)^n, where PV is the present value, r is the rate, and n is the number of periods. Here, PV = $1.25, r = 7% or 0.07, and n = 1 year. So, FV = $1.25 * (1 + 0.07)^1 = $1.25 * 1.07 = $1.3375. Next year, he will also receive a dividend of $1.50 per share. Therefore, the total homemade dividend per share next year will be $1.3375 + $1.50 = $2.8375, which rounds to $2.84.

Ricardo Owns 642 Shares of Sonic Automotive Stock