Helluva stock currently pays a dividend of $1.20 per share. Dividends are expected to increase at the rate of $0.10 per share for the next eight years. Determine the current value of Helluva common stock to an investor who expects to be able to sell the stock for $28 after 5 years. Assume that the investor requires a 12 percent rate of return on the security.
A) $66.00
B) $28.00
C) $21.20
D) $15.88

Question

Quizplus · Accepted Answer

First, we need to calculate the present value of the dividends for the next eight years using the formula for the present value of an annuity. We know that the annual dividend payment increases by $0.10 per share, so we can use the formula for the present value of a growing annuity:
PV = PMT / (r - g) * (1 - (1 + g / r) ^ -n)
where:
PMT = the annual dividend payment
r = the required rate of return
g = the rate of dividend growth
n = the number of years
Using the values given in the problem, we get:
PV = $1.20 / (0.12 - 0.10) * (1 - (1 + 0.10 / 0.12) ^ -8) = $8.40

Next, we need to calculate the present value of the expected selling price of the stock after 5 years using the formula for the present value of a single cash flow:
PV = FV / (1 + r) ^ n
where:
FV = the future value of the cash flow
r = the required rate of return
n = the number of years
Using the values given in the problem, we get:
PV = $28 / (1 + 0.12) ^ 5 = $15.88

Finally, we can calculate the current value of the stock by adding the present values of the dividends and the expected selling price:
Current value = PV of dividends + PV of expected selling price = $8.40 + $15.88 = $24.28

Therefore, the best choice is C) $21.20.

Helluva Stock Currently Pays a Dividend of $1